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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 20349  
Subject: Thanks, guys Date: 10/26/2011 2:22 PM
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Thanks, guys, for being receptive to including discussions of bond investing on this board if done from a value approach. (The board where such discussions could be taking place has all but died, mainly because of their persistent confusion of cash-management with fixed-income investing. But that’s not a problem that concerns us.)

My bet would have to be that most on this board know a lot more about bond investing that they think they do. But indulge me for a paragraph or two while I lay out what I find attractive about bonds. By and large, for a stock investor to do well, the underlying has to do well. But for a corporate bond investor to do well enough, the underlying merely has to not fail. That’s a lesser standard to meet, and the standard is protected by a put to boot (aka, maturity is promised). OTOH, the price of that put is the lesser returns than might come from buying the debt rather the common. (Anecdotally, it’s about a 3.5x disadvantage.) OTOH, the upside of bonds over stocks is their lesser price-volatility. So for a person who is willing to grind through a company’s financials (rather than just make bets about the level/direction of interest-rates) and who really does want (for the most part) buy-and-forget investments, bonds are a good compromise between risk and reward. But rather than talk theory, let’s work through an example.

Because I generally don't attempt to trade junk bonds, I have to game my odds of failure, and what matters to me is my recovery-rate. As an example of how I buy junk, consider Shopko's bonds, several of whose issues I bought years ago on the basis of seeing mention of the company in one of Oakmark's annual reports that I was reading diligently, because I was a shareholder. They were explaining why they were buying the stock for their funds. They were struck by the fact that the company owned a lot of the real estate on which their stores sat (rather than being the typical retailer who depends totally on leasing), and, consistent with GAAP rules, the true market value of their land was likely higher than book-value which the stock market seemed not to be discounting. (Keep in mind that they were doing their DD and looking at the company as a value stock.)

"But, wait a minute", I thought upon reading their analysis. "Retailers generally offer fairly high recovery-rates from Chapter 11 purely on the basis of inventory. These guys have real estate, as well, that could be claimed by creditors. I don't care if they do fail. I'll likely recover my money if I buy their bonds --instead of their stock-- because of favorable recover-rates and where I stand in the credit line."

So I started digging through their financials and came to the conclusion that I could buy their discounted bonds with zero downside risk, i.e., at less than a likely recovery-rate. (Of course, subsequently, they renegotiated their credit facility, effectively subordinating the credits I was buying, changing the risk/reward relationship.) But on the basis of my initial DD, I scooped up nearly everything I could get a hold of, which were 5 each of the two near-term issues and 3 of the longer-term one, as being all that were available at the time --junk is a very illiquid market-- as well as that many bond made a prudently-sized position relative to my account size. One issue matured soon. The others quickly went to trading above par, and I made an average YTM of 17% on those positions, which is modest. But it sure beats the historical 10% something of stocks over the long haul, which is my bogie: better long-term returns from junk bonds than the long-term returns from the SP500, and with no more risk.

Caveat: I would attribute my success in this instance less to skill than the fact of there being easy pickings at the time. With Shopko, I was fortunate enough to put together a couple of obvious facts in a timely fashion. But I’m still in the bond market on a daily and weekly basis, poking around, looking for discounts to value, and I’m still finding situations that merit the attention of value investors. (Two buys this week so far, and about the same last week after mostly taking off the two prior weeks). In other words, if over a year’s time I do 4-6 buys a month, I’m pretty much on target for the shopping and buying I have to do. That’s not a burdensome research pace, and the constant nibbling pretty ensures that I’m looking at most of what should be looked at in the corporate bond world. Wins and losses on individual positions range can from 200% (rare, but 100% is doable) to minus 100%, and the average across your portfolio can be pretty much what you want it to be depending on your tolerance for risk, meaning, stocks or bonds, it makes no difference on a risk-adjusted basis, as it can't, or else the arbs would step in to correct the inefficiency. But of the two asset-classes, I find bonds to be the easier and more interesting.

Charlie
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Author: yazar000 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8038 of 20349
Subject: Re: Thanks, guys Date: 10/26/2011 10:21 PM
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I've been quietly learning from you for awhile on the bonds board & someone gives you unwarranted lip. I'm happy you'll teach here too.
I've got this image of CharlieBonds in a blue superhero tight with a big B emblazoned upon his chest. Yea, a mancrush thing.

There goes CharlieBonds!

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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8039 of 20349
Subject: Re: Thanks, guys Date: 10/26/2011 11:33 PM
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yazar000,

I truly love bonds and think they are a misunderstood, much underappreciated asset-class that can serve as a microcosm for exploring investment theory. But the bond board is all but dead for lots of reasons, whereas value-investing never goes out of usefulness (though it may lose favor from time to time). Ben Graham is as shrewd an observer of human behavior (and frailty) as they come, and a stand-up comedian to boot (in a dry sort of way).

If you need an image to connect me to my handle, try a guy in waders in a small creek, a midge rod in hand he built, casting to native cutthroats. Or put a bike helmet on me and a tee shirt if it's summer, or a wind jacket if it's fall. Or if you want a better image, envision a three-monitor trading station against full windows to the east and south overlooking my garden and a wall of books to my right and a guy running bond scans and building yield-curves in Excel.

Charlie

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Author: Burghy Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8041 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 3:09 AM
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I have some questions about the actual process of buying and selling bonds.

First is liquidity, second is spread. I have found that many of these bonds are highly illiquid. Is there any specific trading strategies we should take? The spread also seems quite wide, probably related to the illiquidity.

A lot of brokers also will totally rip you off on bond trades. What's a good broker that will give reasonable execution?

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8044 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 7:48 AM
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By and large, for a stock investor to do well, the underlying has to do well. But for a corporate bond investor to do well enough, the underlying merely has to not fail.

Charlie


Lawrence Edgar Smith was the first person to show that stocks outperform bonds in the long run. He published his results in 1928 and Ben Graham accused him of causing the 1929 speculative bubble.

Smith theorized on why stocks should outperform bonds and he came up with a statement like yours. I paraphrase because I don't want to look it up: "For a bond to be a sound investment the underlying company has to perform well and the excess profits don't go to the bond holders but to the owners." Basically what this says is that if the bonds are good enough to buy, the stock is likely better. One has to remember that in 1928 bonds were considered investments and stocks were considered speculation. For this reason, "Security Analysis" concentrated on evaluating companies from the perspective of their ability to back the bonds. Security Analysis with a focus on stocks is a newer phenomenon and Smith's statement must be read in that context.

Putting the two statements together, yours and Smith's, the result might be: "Bonds are safer ([for an] investor to do well enough) but stocks (of the same companies) yield more."

Personally I don't see the issue as an either-or proposition, both types of security have their place in a balanced portfolio. When I had bonds in my portfolio they were not for trading but for holding to maturity. When interest rates were high I would buy bonds with 4 to 5 years to maturity. When interest rates were low I ignored bonds. Currently I would be avoiding bonds with yields as low as they are.


As an example of how I buy junk, consider Shopko's bonds, several of whose issues I bought years ago on the basis of seeing mention of the company in one of Oakmark's annual reports that I was reading diligently, because I was a shareholder....

While this might be a good illustration of how to dig up a good bond, the "average YTM of 17% on those positions" is by no means the average yield a bond investor can expect year in and year out. That is as much cherry picking as saying that microchip cores are a good investment based on ARMH's performance since Jan 2010. I had ARMH in other time frames and lost money some time and doubled my money at other times

http://softwaretimes.com/npi%20portfolio/npi%202010.php

Buying high yield (junk) bonds I don't think would not be of interest to a "value" board any more than buying highly speculative stocks, momentum stocks or cigar butts. Aside from that I think a good discussion of investment grade bonds would be more than welcome here.

Denny Schlesinger

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8046 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 8:03 AM
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Buying high yield (junk) bonds I don't think would not be of interest to a "value" board any more than buying highly speculative stocks, momentum stocks or cigar butts. Aside from that I think a good discussion of investment grade bonds would be more than welcome here.


It should say:

Buying high yield (junk) bonds I don't think would be of interest to a "value" board any more than buying highly speculative stocks, momentum stocks or cigar butts. Aside from that I think a good discussion of investment grade bonds would be more than welcome here.

In case anyone cares to read it:

Common Stocks as Long Term Investments by Edgar Lawrence Smith
http://www.amazon.com/Common-Stocks-Long-Term-Investments/dp...

The funny thing is that Smith set out to show that bonds were better than stocks, the "conventional wisdom" of his day, but the data showed the exact opposite!

At a minimum, read the two Amazon book reviews, mine and one other:

http://www.amazon.com/Common-Stocks-Long-Term-Investments/pr...

Denny Schlesinger

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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8049 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 11:48 AM
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Denny,

Buying high yield (junk) bonds I don't think would not be of interest to a "value" board any more than buying highly speculative stocks, momentum stocks or cigar butts.

I respectfully disagree. I agree that 17% yields should not be expected by those running a less diverse and robust bond portfolio than Charlie's or by those with less knowledge of the market. There also is no need to take on equity like risk if one invests in equities. But what is the risk difference right now between Ally Financial and BofA? What is the reward difference? Ally rating has been climbing, BofA's has been falling. A magic line drawn in the sand separates them, one as speculative and the other as investment grade creating a gap between their YTM.

It really does not matter if it is a bond or a stock cr@p is cr@p, undervalued is undervalued, pricey is pricey. If you buy a bond in a crummy company you may very well be looking at a BK workout. If you buy stock in a crummy company you may very well be smart enough to sell after taking a large enough loss. If you can buy a bond of a company that is most likely going to survive with more than enough money to pay off its debts that is selling for less than companies of similar quality(may or may not be similarly rated) why would you pay more?

One of the advantages groups like Value Hound Fools have in the bond arena is the ability to run through the financial statements and make judgements of their own. One of the great mistakes of individual investors is not realizing that the companies rating is the starting point of due diligence not a major portion of it. It is not unusual to see a higher rated bond priced similar to ratings of companies one or more rating notches below it, the inverse is also true. Where is the value in this situation? Is the higher rated bond priced lower a value or is the market pricing them one or two notches lower because they move faster than the rating firms? The first scenario is a potential value the second is a potential value trap.

Deep discounting is a very tough a specialized gig in bonds, hunting for value takes virtually the same skills on the bond side as the stock side.

jack

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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8052 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 12:41 PM
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Jack,

I LOVE you! You really do understand the value game and how it might apply to bonds. Thanks for the assist.

Charlie

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8053 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 1:08 PM
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Jack:

Thanks for the reply. Maybe I'm misunderstanding what "value" means to Value Hounds. Would cigar butt investing fit the value category for Value Hounds? My first thought would be that cigar butts are speculative. High yield (junk) bonds and other distressed bonds are the bond version of cigar butt stocks, No?

Denny Schlesinger

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Author: JustMee01 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8058 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 2:21 PM
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Why can't a cigar butt be a value opportunity? Graham hunted cigar butts. Buffett hunted cigar butts early in his career.

Value means buying dollar bills for fifty cents, doesn't it? A security doesn't need to be blue chip to be a good investment. It just needs to be mispriced.

Peter

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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8061 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 4:16 PM
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Denny,

Superb questions. Possibly vague answers to follow.

Would cigar butt investing fit the value category for Value Hounds?

Some value investors adhere to "if its priced low enough even trash can be a good investment" others do not. Some value investors will avoid cigar butts others will take a puff. The difference lies in personality and system. The hard core LTBH value investor is not likely to touch a cigar butt or if they do it is a "speculative" play and sized accordingly. The buy low sell at full value or higher value investor would not see an undervalued cigar butt as speculative because they have no plan to hold long term; their goal is to analyze it for what it is, price it right and then flip it.

High yield (junk) bonds and other distressed bonds are the bond version of cigar butt stocks, No?

For many bond investors there is a difference between "speculative grade" and pure high yield junk. Once we cross the line drawn between spec grade and investment grade it is often pretty easy to see who is pure junk and who may be doing all right. If we use really broad categories the whole category of spec grade is 15x more likely to default then the entire investment grade category. When we get more specific, the companies just below the spec grade line are only 2-4 times more likely to default as the ones just above the line. Or specifically the company's just below the line have a 19% - 30% chance of default. Those are ugly numbers if we are buying the category but once we burrow down a bit further it is possible to find value because 7 out of 10 of these companies pay their debts.

So, some "speculative grade" bonds are cigar butt'ish and these are often nasty cigars in that we are edu-guessing that our work out during BK will be higher than what we paid for the thing. Other "speculative grade" bonds are from companies on the mend or limping along but still possibly vulnerable to some hit to its industry or the economy in general.

This is where analysis is our friend. Ford just had its S&P500 rating raised and Moody's has it on watch for an upgrade. F has spent several years cleaning up their balance sheet. If one was watching Ford and had trust in management one could have bought a "speculative grade" bond on the rise a couple years back. We wouldn't of had to buy it during the terrifying days of govt. auto industry bailouts to have participated although, like the stock market, that is when the best returns could have been gained if we had our DD in the file and were brave enough to pull the trigger. Both Moody's and S&P point out that F is still vulnerable to the auto market's ups and downs. In other words F has done a good job but it may not be completely out of the woods but is really close.

Is F a good value bond buy today? Probably not it does not exactly fly under the radar. The time to catch it was when more people were nervous, when it was "out of favor". For you or someone else it may be good enough or too ugly to touch with a ten foot pole.

Possibly more important to the value investor is the overpriced investment grade bond or the value trap bond. The rating houses may be willing to wait out a rough patch for a company without changing its rating. It is at this point we need to choose who to believe the market that has discounted the price relative to its rated peers because of the rough patch or the rating house which has maintained is rating. Proper DD is required to make an educated choice.

I pulled a search at Schwab (which is not a great place to shop for bonds) and found a Masco bond rated BBB/Ba2 Price 103, coupon 6.125, maturity 10/3/16, YTM 5.421 to use as an example. Schwab tells me the are on negative credit watch. I hopped over to Moody's free services and they don't have it on watch and Ba2 is already spec grade. Is Masco(stock ticker MAS) speculative or not? Can we expect a MAS bond due in 5 years to be paid to us in full? Are we getting compensated for the risk we are taking if we bought this MAS bond?

Interest rate coverage ratio = 1.3 (in the S&P B- range.)
Current ratio 2.13 (more respectable)
ttm FCFF = 520mil
Interest expense $64mil
Reinvestment rate is negative
Long term debt has dropped 5 mil over last 4q
ROIC/WACC upside down

http://wallstcheatsheet.com/earnings-trading-markets/masco-c...

http://localizedusa.com/2011/10/26/masco-mas-shares-given-ne...

Is MAS 5.421 YTM enough compensation for the above risk over the holding period? Its current bond price suggest more people think it will survive then crater.

jack

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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8063 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 4:44 PM
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Is MAS 5.421 YTM enough compensation for the above risk over the holding period? Its current bond price suggest more people think it will survive then crater.

Jack,

I'd suggest that buying MASCO now is coming too late to the party. I can see from my spreadsheet of holdings that my entry into their 7.75's of '29 was at 65.298.

That's a price which does create Ben Graham's suggested "margin of safety" and a modest 13.7% YTM (under one method, though just 12.3% YTM by another). But even discounting for a forward inflation-rate of 5%, the bond, at that price of 65 something, would offer the would-be investor a positive, real-rate of return. Whereas buying Masco's 6-1/8's of '16 at 103 (all-in) creates no margin of safety.

By my methods of discounting for inflation, the annual loss to a would-be investor from just a 5% inflation rate would be (0.1%). True, that's closer to being a scratch than a genuine loss. But paying taxes on the income-stream would put that purchase into the loss column, to say nothing of the risk created by the distance of the entry-price to a likely Chapter 11 workout.

In other words, by Graham's terms and methods, to buy Masco's debt at present-day prices is speculating. It is not defensive, responsible value-investing.

IMHO, 'natch.

Charlie

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8067 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 6:01 PM
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Value means buying dollar bills for fifty cents, doesn't it? A security doesn't need to be blue chip to be a good investment. It just needs to be mispriced.

Peter


Good answer, but... Are you sure a Value Hounds posse won't run me out the the Internet if I bring up for consideration an underpriced POS? LOL

Denny Schlesinger

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Author: yazar000 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8070 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 9:43 PM
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Are you sure a Value Hounds posse won't run me out the the Internet if I bring up for consideration an underpriced POS?

If its some other POS than the one I'm chasing, spill it. If its the same as my POS, I doubt they could run you off by your lonesome, let alone two of us. It won't matter what was said if we are right. I don't mind laying myself on the sword but I will yield.

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Author: JustMee01 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8075 of 20349
Subject: Re: Thanks, guys Date: 10/27/2011 10:28 PM
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Denny,

Are you sure a Value Hounds posse won't run me out the the Internet if I bring up for consideration an underpriced POS? LOL

Fire away. There's a place for a steaming pile in a well rounded port. Anyway, no true Hound can pass on anything without at least a sniff to check it out. One Dawgs garbage is another's Breakfast. ;-)

Peter

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8087 of 20349
Subject: Re: Thanks, guys Date: 10/28/2011 7:42 PM
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Buying high yield (junk) bonds I don't think would be of interest to a "value" board any more than buying highly speculative stocks, momentum stocks or cigar butts. Aside from that I think a good discussion of investment grade bonds would be more than welcome here.


I don't understand why you would say this. I am interested in any asset class provided that it is selling for some reasonably quantifiable discount to fair value. Graham's cigar butts (his net-nets) made Ben some pretty good returns that I'd be satisfied with, 20%+ iirc, over 15 or 20 years. Not too shabby.

17% annulized over 3 years is more than adequate especially when you consider that the realistic downside was maybe breakeven or at worst lose 60%? (not sure, I don't remember the specifics if they were given). A poorly selected stock will get you zero.

In Margin of Safety, Seth Klarman details what he called one of his best investments ever, those being buying Texaco bonds after they declared bankruptcy from the Penzoil ruling. The most attractive part was that there was very little risk.

From my own personal experience, the exchange traded debt and preferred stock I bought during the crisis performed most satisfactory. They doubled in less than 2 years, or there abouts, while at the same time paid 12% to 19% per year on my invested dollar. Not a loser in the whole bunch.

Bonds can definately be value investments. No doubt about it.

The thing I'm not interested in one little bit is investment grade bonds selling near par. I'd much rather buy a stock with a dividend yield greater than 3%.

Rich

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8088 of 20349
Subject: Re: Thanks, guys Date: 10/28/2011 8:08 PM
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I don't understand why you would say this. (No interest in junk bonds, cigar butts, etc.)

Rich


I guess my mental image of what a value hound's mental image of "what value is" was wrong. ;)

Denny Schlesinger

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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8094 of 20349
Subject: Re: Thanks, guys Date: 10/29/2011 2:55 PM
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Rich,

The thing I'm not interested in one little bit is investment grade bonds selling near par. I'd much rather buy a stock with a dividend yield greater than 3%.

There are two broad approaches to buying at or above par: the first is "never buy above par", the second believes par moves with interest rates.

Example:

A 10 year zero paying 3% has a duration equal to the time left to maturity because the entire payout is at the end which makes for a simple illustration.

If interest rates rise by 1% the second group recognizes that par is now 90 not 100; any price above 90 is buying above par. If interest rates drop by 1% the second group recognizes that par is now 110 not 100; any price above 110 is buying above par.

Individual bonds have two major inputs that inform their price: current interest rates relative to issue yield and the risks associated with that particular bond.

Refusing to pay at or above par is not a bad policy and it often screens out many good opportunities.

Make sense?

jack

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8096 of 20349
Subject: Re: Thanks, guys Date: 10/29/2011 5:39 PM
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Hi Jack,

I understand the relationship between prevailing interest rates and the effect they can have on market prices of bonds relative to par.

My point is that at a 3% or less coupon the bond holder is neither adequately compensated for interest rate risk nor default risk. And, that an investor would be better off buying the dividend paying equity paying 3% or greater because at least then they would have the hope that growth in that dividend over time would at least keep pace with inflation and with a little luck price appreciation would lead to some real profits.

The buyer of the 3% bond, today, has no hope at all over the long term.

Rich

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8099 of 20349
Subject: Re: Thanks, guys Date: 10/29/2011 7:40 PM
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My point is that at a 3% or less coupon the bond holder is neither adequately compensated for interest rate risk nor default risk.

stay away from absolutes!

the American Century 2025 Zero coupon bond fund is up - what - 20.8% ytd. And I bet the yield on it wasn't much over 3% when it started. The Pimco 25+ Yr Zero Cpn U.S. Trsy Idx ETF (ZROZ) is up....oh...57% ytd per M* on an NAV basis.

Sure, you can argue that these investments can entail great risk, but strech and bond out far enough and amazing things can happen (bot good and fantastically bad).

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8100 of 20349
Subject: Re: Thanks, guys Date: 10/29/2011 11:30 PM
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minor thing - ah, the zero coupon bond fund has no coupon. So it would have been a neat trick to start above 3%. The American Century product actually has "an anticipated value at maturity" of 09-24-25 which roughly corresponds to a, per the website, 2.91% "anticipated growth rate". What is peculiar to me is that the same website reports a 2.5% 30 day SEC yield. For a zero coupon bond fund. Umm....this sure seems odd, right?

my only point, lost in the details, was that even bonds with small coupons can do well if the bond is very long-term and you have another drop in rates...

(course rich already knows this, but...)

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8102 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 5:59 AM
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Hi SB,


the American Century 2025 Zero coupon bond fund is up - what - 20.8% ytd. And I bet the yield on it wasn't much over 3% when it started. The Pimco 25+ Yr Zero Cpn U.S. Trsy Idx ETF (ZROZ) is up....oh...57% ytd per M* on an NAV basis.


I must not have been very clear. I was not talking about funds.

What I was attempting to discuss were the merits of buying, today, an investment grade rated company's stock vs their bonds, where the stock yields >3%. And, my assumption was that same company's bonds yield <3%. For example, let's use JNJ.

If you had to pick solely between the follow two choices, today, for all of your personal money which would you pick:

A) JNJ stock.

B) JNJ bonds.

And hold them for the long term, say 10 years.

I would pick A) absolutely.

But, since you brought them up, how did those funds achieve those eye popping returns? I'm not familiar with them but suspect they used some form of leverage that benefited greatly from QE and the flight to safety we've experienced recently. But, that's just a guess.

Rich

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8103 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 7:14 AM
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Rich:

Not to disagree with you but comparing a bond to a stock is not all that easy. If you have the choice between a JNJ bond with a 3% coupon and JNJ stock with a 3% dividend you have two very different offers.

a) If JNJ, the company, does very well, the bond is capped at 3% while both the stock and the dividend might rise.

b) If JNJ, the company, does poorly, you still get the 3% yield from the bond but the dividend might get cut and the stock price might drop.

c) If JNJ, the company, blows up, the stock might go to zero but you might get something back from the bond

Assigning a risk factor to these scenarios is anything but simple. If you see healthy financial statements, usually the best you can do is to say that JNJ, a 100 year old company, is not about to go bust and you'll opt for the stock -- maybe.

I say "maybe" because there is something we always omit from Foolish discussions, the wealth and financial circumstances of the investor. Suppose you want to have a $60,000 a year pay-out from your investments when you retire (all the numbers that follow are just very rough back of the envelope estimates for illustration purposes only). You would need a portfolio between $500 K and a million. At $500,000 or less, you probably should go for the stock. At $5 million or more you probably should go for the bond.

Not too long ago LeKitKat brought to the board a discussion about cash in the portfolio. In the article she referenced there is the very interesting concept of an "efficient" vs. a "sturdy" portfolio. The stock would likely qualify as an "efficient" investment while the bond would be a "sturdy" investment.

The amount of wealth is not the only factor to take into account. At 72 I'm not likely to be able to get a job or even to compete with young programmers writing code from home. At peak "adulthood" you are getting your top revenue stream from your work. The risks you can take with your portfolio at these two ages is very different, mitigated, as I said above, by the size of the portfolio. So we have four stages (roughly):

1.- Young, small port
2.- Young, big port
3.- Old, small port
4.- Old, big port

Add to that family, pension plans, insurance and government aid and the variations become endless.

All the above is only to say that hard positions are not for everybody.

Denny Schlesinger

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8104 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 8:39 AM
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Hi Denny,

I agree with everything you've said and I think that you raise some valuable points for all to read.

Fwiw, I'm still in my earning years (52) and have a long way to go until I reach my $1.3 million retirement savings goal. So, my views do tend to be skewed towards someone in my position. My bad.

I'd also like to add that I wouldn't be opposed to someone (in any age bracket) investing in a safe bond (or bond fund - which at this point I'm more apt to do) with a portion of their holdings for the express purpose of holding for a short time until better pricing in stocks were available - a pseudo cash position, if you will. But, with the proviso that this be done with only a small portion of the cash position due to the risks involved.

I'd also add that someone post-retirement might benefit from reading "The Little Book of Value Investing." It contains a passage about a widow who had a comfortable savings early in retirement and who followed conventional wisdom at the time and had all of her savings in bonds. Over the course of her retirement lifetime, inflation took its toll and as she got into her later years had difficulty meeting her living needs. Fortunately for her, her sons were able to provide for her needs and she had no worries. Browne's solution was that she should have at least had a portion of her holdings in dividend paying stocks too.

http://www.amazon.com/Little-Value-Investing-Books-Profits/d...

And, with today's historically low interest rates, I think that it is even more important to do that very thing, today, for someone in retirement and that has many years left to go. Safety first, though. And, remember that diversifying is your friend.

Rich

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8105 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 11:49 AM
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But, since you brought them up, how did those funds achieve those eye popping returns? I'm not familiar with them but suspect they used some form of leverage that benefited greatly from QE and the flight to safety we've experienced recently.

fwiw, no leverage - these are just long-dated zero coupon bond funds that are by definition super-sensitive to any change in rates since there is no coupon associated with the bond itself; the 2025 AC fund has current NAV at $78.31 and will mature in 2025 at $116.76 so if rates go down then that gain upon maturity is by definition more valuable (cause rates are lower) so you get big upward changes in NAV with any downward change in interest rates. Works the same in reverse. The Pimco ETF is obviously even more volatile as the bonds are (apparently fixed to) maturing 25 years from now.

Again, these aren't for the faint of heart, but if you think for example that rates are headed still lower then this an interesting way to play that theory. You could also short the Pimco ETF if you are convinced rates are headed higher. Not for the casual investor, especially since you don't want to hold zero's in a taxable account cause Uncle Sam makes you pay taxes on phantom interest (I own one zero from GAMCO).

https://www.americancentury.com/funds/fund_detail.jsp?fund=9...
http://www.pimcoetfs.com/FundInfo/Pages/PIMCO25+YearZeroCoup...

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8106 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 11:53 AM
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If you had to pick solely between the follow two choices, today, for all of your personal money which would you pick:

A) JNJ stock.

B) JNJ bonds.

And hold them for the long term, say 10 years.


two minor things - nobody is going to hold them 10 years if the price spikes well beyond reasonable value, so if I thought interest rates were going to drop something far lower than even's today low rates, then sure, you could buy the bonds and do better, especially if those JNJ bonds mature 30 years from now, especially since the traditional relationship between rates and stock dividend yields seems to be completely off today. Course, I wouldn't make a bet that rates are going lower, so....

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8107 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 12:03 PM
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If JNJ, the company, does very well, the bond is capped at 3%...

Above statement is not quite true - the COUPON is capped at 3%. A bond doesn't have to trade at PAR, so you can sell it and capture a much higher gain. So if rates go down from here, then the value of the bond can trade far and away above what you buy it for, especially for long-dated bonds.

Course, this is somewhat academic if you aren't using something like Zions per CB. At TDA for example they don't even give you any bond sell prices which is nuts when you think about it.

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Author: RWRocksOn Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8108 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 12:04 PM
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I say "maybe" because there is something we always omit from Foolish discussions, the wealth and financial circumstances of the investor. Suppose you want to have a $60,000 a year pay-out from your investments when you retire (all the numbers that follow are just very rough back of the envelope estimates for illustration purposes only). You would need a portfolio between $500 K and a million. At $500,000 or less, you probably should go for the stock. At $5 million or more you probably should go for the bond.

Captain -

A great point about the wealth and financial circumstances of the investor. Let's throw in another - the investors personal time cost. We always go on about the cost of having someone else invest for you - but I find increasingly little time to spend on investing between a booming medical practice and two (for the time being) small children. Suffice to say, I believe that the individual investor (different than someone who manages OPM like Spock/Martian) should focus on improving the odds of achieving your personal life goals - which mean balancing work, family, vacation, health and time spent investing. I get up at 5 every morning to hit the gym - I could spend that 90 minutes reading investing or professional literature but what is the point of it all if you die of a heart attack before even collecting Social Security?

RWS

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Author: SpocksBrainV Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8109 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 12:19 PM
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At $500,000 or less, you probably should go for the stock. At $5 million or more you probably should go for the bond.

ironically, I see it mostly in reverse - if you really must have 60k, and will draw out 60k regardless of market, it is perhaps more prudent to use bonds which have specific termination dates and will thus give you exactly what you want (assuming they pay off in maturity - if not, there is no hope here anyway) vs. risking the volatility of the stock market. Course, you aren't going to get 60k with 500k (right now at least) in most bonds unless you can do the specialized work that CB can do. With 1m, you've got a fighting chance.

Nobody probably gives a rip, but listed preferreds for closed end funds can be an intersting income alternative, especially if all one cares about is the coupon. These have the advantage of being relatively easy to understand (no company analysis) with a built-in backstop of a likely call if they violate specific coverage ratios. As an alternative to - say - fixed annuities - they make a lot of sense (esp. something like TY- which usually trades below its call price). Link below:


http://boards.fool.com/fwiw-income-from-cef-preferreds-28963...

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Author: captainccs Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8110 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 12:25 PM
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Above statement is not quite true - the COUPON is capped at 3%. A bond doesn't have to trade at PAR, so you can sell it and capture a much higher gain.

Correct, but if a little old lady or granddaddy has them it's more than likely to hold to maturity. All the bonds I ever owned were for the purpose of holding them to maturity. In addition to selling the bond, you'd have to figure out what to do with the cash. That's not the kind of thing you want to handle if your purpose in life is other than to watch the markets daily.

This past Monday, after I returned from my errands, I could no longer connect to secure websites in the US, not to my credit card nor my brokerage accounts. The problem was hard to track down and my ISP didn't solve it until yesterday (Saturday). The funny thing is that this "withdrawal" pointed out to me that I was spending way to much time on the market.

So, while you are technocally correct, Yogi applies: "In theory, theory and practice are the same. In practice, they are not." LOL

Denny Schlesinger

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Author: CM001 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8112 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 2:06 PM
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have a long way to go until I reach my $1.3 million retirement savings goal

Can you explain how you arrived at $1.3 Million?

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Author: CM001 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8113 of 20349
Subject: Re: Thanks, guys Date: 10/30/2011 2:26 PM
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listed preferreds for closed end funds can be an interesting income alternative

Sometime last year I found REIT board and slowly started investing in REIT preferreds. For those who are looking for income they are a good option. The same caveats like liquidity, interest rate, economy, inflation etc applied them too.

For me, as an individual investor with limited capital, they are wonderful options to earn 6~7% without much risk. With some added risk you can look at few 9% yields also.

They helped me whether the volatility and with overall return.

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8119 of 20349
Subject: Re: Thanks, guys Date: 10/31/2011 6:23 AM
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Can you explain how you arrived at $1.3 Million?


A long, long time ago (when I was in my 20s) Vanguard put out a financial calculator of sorts that allowed one to estimate the funds needed in retirement. It was fairly sophisticated and took into account the major variables including inflation. I worked for weeks playing with the inputs and assessing the outputs. My primary assumptions were that SS would be bankrupt for me and so I didn't count it. I did assume medicare would somehow survive, perhaps a risky bet. The other financial assumptions is that the income thrown off from that amount is what we will likely need to live on. I didn't want to plan for using capital to live on, although that would be a last resort.

Over the years, various sources publish different techniques for calculating how much you need to have saved for retirement. When I see one, I recalculate the number. That number has always been about right, for us.

Everyone's situation is different. So, don't assume that number will work for your situation.

I'm sure if you searched Google you could find a number of different sources to aid in calculating your needed savings for retirement. If you don't know where you are going, it's very hard to get there.

Rich

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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8128 of 20349
Subject: Re: Thanks, guys Date: 10/31/2011 11:35 AM
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Rich,

My point is that at a 3% or less coupon the bond holder is neither adequately compensated for interest rate risk nor default risk.

No argument here.

And, that an investor would be better off buying the dividend paying equity paying 3% or greater . . .

That is the tough part. Neither my parents nor my In-laws are emotionally built to agree. Both groups are smart enough to see the logic and both have been burned on the principal side when individual stocks or the market in general blew up. All four had parents that lived into their 90's so they have a good chance of living +20 years which could capture the added value the equity market offers. To them the risk is not worth it. 3% isn't good enough but it also is not a 50% haircut, the 2nd is far more dangerous because they are no longer employed and cannot replace lost capital through an exchange of labor for $$.

jack

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Author: TMFRichDad Big gold star, 5000 posts Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8146 of 20349
Subject: Re: Thanks, guys Date: 10/31/2011 8:18 PM
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Hi Jack,

That is the tough part. Neither my parents nor my In-laws are emotionally built to agree. Both groups are smart enough to see the logic and both have been burned on the principal side when individual stocks or the market in general blew up. All four had parents that lived into their 90's so they have a good chance of living +20 years which could capture the added value the equity market offers. To them the risk is not worth it. 3% isn't good enough but it also is not a 50% haircut, the 2nd is far more dangerous because they are no longer employed and cannot replace lost capital through an exchange of labor for $$.

<Long story, not much value, casual reader may want to move on to the next post>

Yup, I can identify with exactly what you are saying. My father was born in 1926 and grew up during the depression.

Stocks? Too risky. The stock market is a casino. Even though he was only a young child during the depression, it left a lasting impression that is a major part of his inner self. Curious thing is that he is the youngest of 8 and he did have an older (by only a few years) brother that didn't share his fear of the stock market. Also, curious is that he holds about $10K (a small percentage of the total port) in GMAC bonds and even though he knew the market price of them during the crisis it didn't phase him in the least. He's content to hold till maturity.

He's now 85 and been retired for 30 years and during a time period where inflation was reasonably low by historical standards, I believe.

Still, for a fair number of years I've been seeing signs that things are starting to get a little tight. I'm convinced that inflation is taking a toll much like the widow in the Browne book I linked to earlier.

Just like the Browne' widow, neither of my parents have anything to worry about. Between my brother and I, we will see to it that they are taken care of no matter what. Although, I do worry that they are so proud that we might not be aware of just how bad things are if it should get that way because they certainly wouldn't say anything.

I can respect their concern for the stock market. But, it still makes little sense to me. If a diversified list of strong companies was selected and the stock held (with homework as Cramer says) through thick or thin and with the same tenacity they show with their bonds, I believe they'd be better off in the long run. All that really matters is if the dividend checks keep flowing. If "it" ever hits the fan that it takes out the stock market, permanently, then the effect on the bond market would necessarily be quite painful financially too I would think. So, in the end it probably wouldn't matter where our money is invested. We'd all be broke if "it" happened.

Maybe I'm wrong. Maybe not. But it doesn't matter, my father's mind is made up and there's no changing it. Guess that's where I get my stubborn streak. :)

</Long story>

Rich

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Author: TMFMurph Big gold star, 5000 posts Old School Fool Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8312 of 20349
Subject: Re: Thanks, guys Date: 11/13/2011 6:10 PM
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...I believe that the individual investor (different than someone who manages OPM like Spock/Martian) should focus on improving the odds of achieving your personal life goals - which mean balancing work, family, vacation, health and time spent investing. I get up at 5 every morning to hit the gym - I could spend that 90 minutes reading investing or professional literature but what is the point of it all if you die of a heart attack before even collecting Social Security?...

Hi RWS!

Great thoughts above....and reminds me of a response once posted to a question about what to do once one has somewhat "made it" financially:

http://boards.fool.com/hi-paul-rather-than-give-you-specific...

I should note that I have added a fourth "L"...my lovely wife Leslie! ;-)

Cheers!
Murph
Home Fool

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Author: hockeypop Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8320 of 20349
Subject: Re: Thanks, guys Date: 11/14/2011 6:29 AM
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Murph: Your post was GREAT in 2005 and great now!!!!

Your L's beat my three for keeping our marriage together. Best to have 3, Lust, Like and Love. There have been times in 32+ years we've got to only one, but worked to get back to all three. Used to be my L's would get at "eye roll" from DD, but now that she's married, I get a wink. GREAT post!

Hockeypop

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Author: TMFMurph Big gold star, 5000 posts Old School Fool Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8322 of 20349
Subject: Re: Thanks, guys Date: 11/14/2011 10:08 AM
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Thanks Hockeypop!

Nothing wrong with your "L's". ;-)

Cheers!
Murph
Home Fool

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