Wednesday, September 5, 2012

Ameren AEE - Junk Bond - over 8% yield

English: Logo of the band "The Junk Bonds...English: Logo of the band "The Junk Bonds" Português: logotipo da banda "The Junk Bonds" (Photo credit: Wikipedia)
Any bond will do.

Alfred Ferol and I were talking about bonds over coffee the other day.   He drifted off subject to point out that; investors seem to have a penchant for buying yesterday’s best investment.

Why would you pay a premium for an investment that will guarantee to return to you upon maturity less principle than you invested?  Investors are putting money in bonds and yikes bond funds because they have done so well in the past.   Even sophisticated investors, Alfred tells me, are sticking with ideas like I am 70 years old and I should have 70% of my investments in bonds.    I do not know when the bond market bubble will burst but it will and those who paid a premium for bonds for whatever reason will find they cannot sell them and will have to hold to maturity.   It’s like Woody Hayes’ view of the pass.  In football, a forward pass will have one of three results and two are bad.  

Yet, when you can find a bond that sells at a discount and backed by a company with decent fundamentals, you receive interest every day you own the bond and you have a chance for a significant capital gain.   When the bond matures, and you get $100 for something with a cost basis of less than $100,  a gain on your investment is highly likely, not guaranteed, but highly likely.

Junk bonds, also known as high yield bonds, have been in the news lately as we income investors, hungry for yield, try to find any bond that will keep our cash flow up and our principle safe.

I like an Ameren Electric Generator (AEE) bond that matures in 2020.  The bond coupon is 6.3% but it is selling between $85 and $88 a bond.   Based on the price I paid, $87.35, the bond yields 8.6% on my principle.

I used to own AEE common stock.  It is a utility with a yield of over 4 percent.  During the past few years, AEE has made some chances that made me nervous.  The earnings are all over the place and therefore, AEE is not a dividend machine.  Moreover, I could rarely find a covered call so I sold it.   I noticed this bond with my routine search of the SIFMA site

Two years ago, just before I published this web/blog I wrote about a Lennar Bond.  Lennar is a homebuilder with fundamentals a little better than the other homebuilders.  I found a bond selling at a discount ($88.73) with a coupon of 5.6% so I bought it.   During the past two years, the bond value increased to between $105 and $106.  This bond will mature in 2015.  If I hold the bond to maturity, the most I will get back is $100.   Therefore, I sold the bond at $105.5 for a total yield (interest plus capital gain) of greater than 25%.   I relate this example to you as an example of how carefully selected bonds, even in this very expensive bond market, can be purchased at a discount and can make you money.

Very Truly Yours,

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