The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [165]
We do know, however, that the group of convertible issues floated during the latter part of a bull market are bound to yield unsatisfactory results as a whole. (It is at such optimistic periods, unfortunately, that most of the convertible financing has been done in the past.) The poor consequences must be inevitable, from the timing itself, since a wide decline in the stock market must invariably make the conversion privilege much less attractive—and often, also, call into question the underlying safety of the issue itself.† As a group illustration we shall retain the example used in our first edition of the relative price behavior of convertible and straight (nonconvertible) preferreds offered in 1946, the closing year of the bull market preceding the extraordinary one that began in 1949.
TABLE 16-1 Price Record of New Preferred-Stock Issues Offered in 1946
A comparable presentation is difficult to make for the years 1967–1970, because there were virtually no new offerings of nonconvertibles in those years. But it is easy to demonstrate that the average price decline of convertible preferred stocks from December 1967 to December 1970 was greater than that for common stocks as a whole (which lost only 5%). Also the convertibles seem to have done quite a bit worse than the older straight preferred shares during the period December 1968 to December 1970, as is shown by the sample of 20 issues of each kind in Table 16-2. These comparisons would demonstrate that convertible securities as a whole have relatively poor quality as senior issues and also are tied to common stocks that do worse than the general market except during a speculative upsurge. These observations do not apply to all convertible issues, of course. In the 1968 and 1969 particularly, a fair number of strong companies used convertible issues to combat the inordinately high interest rates for even first-quality bonds. But it is noteworthy that in our 20-stock sample of convertible preferreds only one showed an advance and 14 suffered bad declines.*
TABLE 16-2 Price Record of Preferred Stocks, Common Stocks, and Warrants, December 1970 versus December 1968
(Based on Random Samples of 20 Issues Each)
(Standard & Poor’s composite index of 500 common stocks declined 11.3%.)
The conclusion to be drawn from these figures is not that convertible issues are in themselves less desirable than nonconvertible or “straight” securities. Other things being equal, the opposite is true. But we clearly see that other things are not equal in practice and that the addition of the conversion privilege often—perhaps generally—betrays an absence of genuine investment quality for the issue.
It is true, of course, that a convertible preferred is safer than the common stock of the same company—that is to say, it carries smaller risk of eventual loss of principal. Consequently those who buy new convertibles instead of the corresponding common stock are logical to that extent. But in most cases the common would not have been an intelligent purchase to begin with, at the ruling price, and the substitution of the convertible preferred did not improve the picture sufficiently. Furthermore, a good deal of the buying of convertibles was done by investors who had no special interest or confidence in the common stock—that is, they would never have thought of buying the common at the time—but who were tempted by what seemed an ideal combination of a prior claim plus a conversion privilege close to the current market. In a number of instances this combination has worked out well, but the statistics seem to show that