There are always people who are ready to advise you to stay out of the market altogether. "The market is just too high for anybody to stay in," they say. On the other hand, loyal followers of common stocks, especially the growth-type stocks, insist that common stock is the only vehicle for participation in the nation's explosive growth.

For those who are neither willing to go all out for common stocks nor resigned to stay away from the market altogether, convertible bonds may be an ideal solution.

A convertible bond or convertible debenture bond has two major investment appeals: limited risk of price decline and the possibility of important price appreciation. It is just about the surest thing in characteristically unsure Wall Street. This is especially so when the market looks bad; this would be the time for investors to turn to convertible bonds as a means of obtaining protection against capital loss while maintaining a potential equity position through the conversion features of this type of obligation.

The two primary conditions for buying convertible bonds are, first, selling at moderate premiums above their value as investment and, second, possessing attractive appreciation potential based on favorable long-term prospects for the equities into which they may be converted. The former is important because bonds may prove almost as vulnerable as their underlying stock if they should be selling well above their face value. The latter is important because the price of convertible obligations is not likely to appreciate in a basically weak company.

The value of a convertible bond or convertible debenture must ordinarily lie within a region specified by two limits. At the lower limit, is the straight debt value of the debenture, while at the upper limit lies the conversion value as determined by the current market price of the common. It is possible for the conversion value of the common to fall below the straight debt value, but in this case the value of the debentures would most probably settle near the straight debt value.

To sum up, the value of the debentures has a fairly stable lower limit, but an upper limit normally restricted only by the value of the common.

Analysts caled this lower limit a "theoretical floor" below which convertible bonds are not expected to decline in the event of further weakness in the common stocks to which the bonds are convertible. This floor is the estimated value of the bond without a conversion privilege. Of course, the estimated investment value changes with the fluctuations in interest rates. As interest rates rise, the investment value declines, and vice versa.

No one can expect a safer investment than one which has almost unlimited potential for upside movement while its downside risk is virtually limited by the straight debt value of a bond. "The upside potential in a convertible bond," in the words of a Goodbody & Co. study, "depends upon the leverage in the conversion privilege, the closeness at which the bond sells to conversion parity, and the extent of the rise in the common."

The Goodbody study explained the "conversion privilege" as a "leverage" in the following example. Said Goodbody: "If a $1,000 bond is convertible into 20 shares of common stock and the common sells at 50, the conversion parity for the bond would be 100. Under these conditions, and assuming the bond is selling around 100, each point rise in the common stock would result in a two point rise in the bond."

In order to show you how to analyze and evaluate convertible bonds, let's take a close look at a few of the nine recommended by the December 29, 1960, Goodbody study together with its data and reasons, particularly in relation to their investment value and conversion privilege.

                                                                           Price       Value         Invest-
                                 Bond       Current    Conv.   Of           In               ment
                                 Price       Yield       Price    Common Common    Value
Boeing Airplane
41/2                          101         4.4          50        37           74.0           80
Burroughs
41/2’s, 1981             110         4.1          38.96   27           69.3           95
Consolidated Edison
4’s, 1973                  112         3.6          61*      67           109.8         96
Phillips Petroleum
41/4’s, 1987             115         3.7          50        54           108.0         96

*Each $100 debenture is convertible into two common shares upon payment of $22 cash.

First, let's consider Phillips Petroleum 4¼'s 1987. Fundamentally, the company stood out as one of the more attractive issues in the oil group because of its large stake in petrochemicals and natural gas. By steadily adjusting operations to current and indicated trends., Phillips is well ahead of competition in changing from an oil enterprise to an energy producer. Selling then at 115, its debentures, convertible into common at $50 per share, sold reasonably close to conversion parity and returned 3.7 per cent as compared with 3.1 per cent on the common.

In the case of Consolidated Edison 4's, 1973, the company is the largest electric and gas utility operation in the country, serving New York City and most of Westchester County, with indications of continuing its steady growth record. Its 4 per cent debentures are convertible into common at $61 per share, of which $11 is payable in cash. Then selling at 112, which is close to conversion parity, the bonds should be quick to reflect any advance in the price of its common stock.

In the case of Burrough 4½'s, 1981, the company has an excellent long-term growth potential as a major producer of business machines and as a front-runner in bank automation. Then selling at 100, its convertible bonds were priced only moderately above investment value. It is convertible into common stock at $38.96 per share. Though the bonds then sold well above conversion parity, in each of the five years between 1956 and 1960, the common stock sold above the price at which the bonds are convertible into common.

In the case of Boeing Airplane 4½'s, 1980, the company has growing stakes in space and missiles, in addition to its massive orders in heavy jet bombers; the latter still constitutes the bulk of U.S. retaliatory power. At approximately 37, its common stock was seen by a Wiesenberger Investment Report dated December 9, 1960, as selling at high earnings multiple (14.4 times latest twelve-month earnings of $2.59 a share or 9.7 times five-year average earnings of $3.85 a share). Wiesenberger preferred participation in its convertible debentures.

"The 4½ per cent 1980 convertible debentures," said the Wiesenberger report, "represent an alternative way of buying Boeing with less downside risk. Recently 100, the debentures yield 4.5 per cent currently (4.5 per cent to maturity). Trading at a 25 per cent premium over investment value, the debentures offer greater safety than the common. Selling at a 34 per cent premium over conversion value (convertible into common at $50 per share), the debentures would move up with a sharp rise in the common."

Wiesenberger saw a participation in the comparatively safer convertible debentures in such well-situated defense issues as Boeing and Lockheed as a "defensive offense," a twist on the often quoted "The strongest defense lies in offense." In the current state of the national economy, Wiesenberger saw one segment of the national economy most likely to "swim upstream," that is, "the complex of corporations associated with our national defense efforts."

That notwithstanding, defense stocks are still basically cyclical in nature because of their individually inherent uncertainty arising from the unavoidably shifting defense emphasis with the resultant threats of contract cancellations. Therefore, a conservative participation in the fundamentally offensive defense stocks would be purchase, for instance, of Boeing's convertible debentures as the "strongest offense in defense."

For the same reason, the Wiesenberger Investment Report saw Lockheed 3¾ per cent 1980 convertible debentures as representing an alternative way of buying into the prime contractor of the Polaris missile system and such important satellite programs as Discoverer, Midas (infrared devices to detect enemy missile launchings) and Samos (surveillance satellite system). "Recently 116," said the Wiesenberger report, "the debentures yield 3.2 per cent currently (2.7 per cent to maturity). Since the debentures traded at an 8 per cent premium over conversion value (convertible into common at $24.27 per share), they would tend to move closely with the common. Although they sell at a large 48 per cent premium over investment value, the bonds offer relatively greater downside protection than the common."

Another example of "defensive offense" is Northrop Corporation's 5 per cent convertible bonds due 1979 which was suggested by Newburger & Co. as a commitment with "limited risks." A major defense contractor, Northrop covers such varied fields as electronics, optics, communications and electromechanics.

"The desirability of an interest in a space and missile company is apparent," said Newburger researchers, "but through the medium of common stock the risk is usually large. We suggest a commitment with limited risks through the convertible bonds of  Northrop. Each $1,000 bond is convertible into 26 shares of the common, now $40 a share, which have a total market value of $1,040. This is in contrast to the price of the bond, which is $1,140. Thus, you are paying for the bond about 10 per cent above the value of the common but gaining considerable safety. The interest on these bonds is earned about 7 times over; we estimate the investment value (that is, what these bonds would sell for without the conversion feature) at 90 to 95."

Eastman, Dillon analysts divided convertible debenture bonds into two groups: convertibles selling near conversion value and convertibles selling near straight debt value.

The first group, including Consolidated Edison 4's, 1973, was "designed to meet the requirements of the investor who is interested primarily in possible capital appreciation. The value of these debentures closely follows that of the common stock. Should the value of the common stock rise well above the conversion price, the investor will share in this rise. On the other hand, should the value of the common fall, the investor is protected by the straight debt or fundamental investment value of the debenture, which limits the downside risk."

The second group, including Phillips Petroleum 4¼'s, 1987, was, according to Eastman, Dillon analysts, "designed to meet the requirements of the investor who wishes to place primary emphasis on the yield of the debentures. Here, because the current market price of the common is far removed from the conversion price, the debentures are selling on their merits as bonds. At the same time, the conversion feature remains a potential added attraction."

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