Educational Programming Video
The Value Line Convertibles Survey
Program 6: Determining The Rank of a Convertible
Based on our proprietary model's expected performance of an issue, convertibles are ranked (and recommended) for either purchase or selling. To determine the rank of a convertible, we take into consideration quite a number of variables, including the rank of the underlying stock, the security's investment value and quality, its current yield and yield to maturity, as well as the projected participation in the equity as determined by our model.
On a weekly basis, a universe of over 3,500 common stocks are ranked by The Value Line Investment Survey - Standard Edition and its sister survey, The Expanded Edition. Although the method used by either survey is similar in most ways, The Standard Edition goes a step further. The Standard Edition assigns a TimelinessTM rank of 1, 2, 3, 4 or 5 (1 being Highest and 5 being Lowest) on the over 1,700 stocks it covers. To derive a rank, the stock's price momentum, and company earnings momentum, over a 10-year historical period, are fed into a computer program, which then assigns a rank to the stock, based on its calculations. Stocks ranked 1 and 2 have the highest possibility of outpacing the equity market over the next year, while stocks ranked 4 and 5 are expected to under-perform the market averages. Stocks ranked 3 are average (or neutral) and should match the market's performance. The Expanded Edition uses a PerformanceTM rank to indicate the price movement of each of the over 1,800 stocks evaluated in its universe over the upcoming twelve months.
In general, a stock with favorable earnings and good price momentum, when matched with the other stocks in the Value Line universe tends to be highly ranked for year-ahead relative price performance. Each survey will rank the top 100 stocks 1 (Highest); the next 300 will be ranked 2 (Above Average); the bottom 100 will be ranked 5 and the 300 stocks before those will be ranked 4. All other stocks will carry a rank of 3 (Average). Changes in ranks generally occur when earnings reports are released, or as a result of relative price movements, or a combination of both.
Unlike the ranks of common stocks, there are no set patterns for the distribution of convertible ranks. In fact, all issues with similar characteristics will be given similar ranks. Nonetheless, a big part of a convertible's potential value and its returns depend largely on how well the underlying common stock is doing or is expected to perform. Thus, the rank of the underlying common stock on a convertible is a major factor in determining the rank of the convertible. Other factors taken into account when determining a convertible's rank include its investment value, current yield and yield to maturity, projected leverage relative to the underlying stock, and call terms. After these factors are considered, we are able to estimate the expected gain a convertible is likely to provide and the degree of risk involved; hence, the "reward/risk" profile by which a rank is assigned to the convertible.
The ranks assigned to common stocks predict price performance only. The ranks assigned to convertibles and warrants predict total return, including both price change and interest or dividend income. Unlike the ranks assigned to common stocks, ranks assigned to convertibles are "risk adjusted."
Investment risk is measured in terms of price volatility. The more up and down movement there is in a price, the greater the risk that the value may not be there when you need it. A convenient way to visualize risk is in terms of the risk in the average stock. If we say the risk in the average stock is equal to 100%, it's easy to visualize the risk in other issues. For example, an issue with a "relative volatility" of 200% would be twice as risky as the average stock, while one with a relative volatility of 50% would be just half as risky. In the Value Line Convertibles Survey, you will find the relative volatility of every convertible and warrant, as well as those of their underlying stocks. This makes it easy to select only those issues whose risk is in a range acceptable to you.
We hope that these sessions are beneficial to you and are providing the necessary groundwork to help you make your investment decisions. Our next session will discuss how to select a broker and how to trade convertibles
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