Tuesday, August 13, 2013

Bonds - Are they worth the work it takes to find one?

Bonds that I like and am willing to buy take so much longer to find than stocks but with some perseverance, the income investor can find one that fits into your portfolio.

Bond Duration Sweet Spot

I like a duration of less than ten years.   Interest rates may zoom up between now and 2023 which would make my bond less valuable.   But if I pick my bond carefully, I am pretty sure I will get my principal back upon maturity.  Upon maturity, I can buy a new bond that pays more interest if interest rates do indeed rise.

I also like a duration of greater than five years simply because I cannot get enough yield on a bond of shorter duration.   I may as well buy dividends.

Bond Rate Sweet Spot

I like a yield that beats typical dividend yields.   If you read this blog, you know that in 2013 I want a dividend yield close to four percent and if I have to settle for less than four percent, I would like a stock that has price appreciation potential and/or covered call income potential.   Therefore, to take the risk of being stuck with a bond for greater than five years, I need more than five percent.   If my bond matures in more than seven years, I would like something closer to six percent.

Buy at a Discount

I do not buy bonds at a premium.  I do not subscribe to the theory that your portfolio allocation between equities and bonds should be related to your age.   For instance if you are 60 years old you are supposed to own forty percent equities and sixty percent bonds.   

If you buy a bond at a premium, in other words it is priced above $100 and you add interest rate risk, you may very well lose money on an investment you were lead to believe is safe.   On the other hand, buying a bond at a discount, less than $100 per bond,  provides you with both interest and a capital gain.   That gain, provided you pick a good bond, will help offset any interest rate risk.

Cinemark, symbol CNK, Bond 5.125% 12/15/2022

Cinemark is not quite a dividend machine for these three reasons: (1) dividend yield is only 2.69%, (2) only two dividend raises since 2007 (3) D/E ratio is higher than I like at 1.94%.   See the table at right which presents CNK's dividend machine fundamentals.

However, some good factors exist that make the bond better than the equity in my opinion.    The company earns $1.11 per share and pays out $.84 per share in dividends.    The company has growth and the company has an interest coverage ratio of 65.69.  I mentioned before, that if you are going to invest in bonds you need to learn about interest coverage ratio.

Today, this bond is trading at about $96.00   The table on the left shows the bond details.  The bond’s cusip is 172441AX5.  This bond is rated BB- which less than investment grade.  That is why you get such a good yield.   This bond is callable in 2017 at $102.563 for a yield to call of 6.69%.   But, do not count on that call.  If I picked right, this bond may trade above par before maturity and then you can sell it if you like.

This is a good fit for my portfolio and you might consider it for yours.

The Money Madam