The Value Line Convertibles Survey

Rank Distribution among Convertibles

The system employed in Value Line’s The Value Line Investment Survey Timeliness Ranking System, which has been in use since 1965, evaluates and rates investment securities for year-ahead performance. Its results are unmatched. Over its long history, the model has discriminated as expected among the different groups; Group 1s had the best returns, and Group 5, worst. Every week, about 3,500 common stocks are assigned ranks based on historical earnings growth and price momentum.

The Value Line Investment Survey and The Value Line Investment Survey Small and Mid- Cap Edition, rank about 3,500 common stocks on a weekly basis. Each stock is given a Performance Rank, ranging from 1 (Highest) to 5 (Lowest), which indicates Value Line’s expected performance of that stock over the upcoming six to 12 months. The ranks are determined by comparing historical earnings momentum and price movements of each stock relative to other stocks in our universe over a time span of at least two years in the Value Line Investment Survey, and over a shorter time span for stocks in the Small and Mid-Cap Edition. Generally, a stock with favorable earnings and price momentum, when compared with other stocks and its own history, tends to be highly ranked for year ahead relative price performance. Although the ranking systems of each survey are separate and differ slightly, only the top 100 stocks are ranked 1 in each case. The next 300 stocks are ranked 2. The bottom 100 stocks are ranked 5, and the 300 stocks above those are ranked 4. Stocks that are average are ranked 3. Changes in the Performance ranks generally occur as new earnings reports are released, or as a result of relative price movements or a combination of both.

The Convertible Rank System

Unlike the ranks of the common stocks in The Value Line Investment Survey and The Value Line Investment Survey Small and Mid-Cap Edition, there are no set patterns for rank distribution among convertible securities in the Value Line Convertibles Survey. All issues with similar characteristics are given similar ranks. Much of the potential value and returns of a convertible depend largely on how well its underlying common stock is expected to perform. Therefore, the rank of the underlying stock is one major factor in determining the rank of a convertible. Other factors taken into consideration include the investment value, the current yield and yield to maturity, leverage projections relative to the underlying common stock, and call/put terms. From these factors, we are able to estimate the expected gain that a convertible is likely to provide as well as the degree of risk involved.

Rank Distribution

A data sort of our convertible database as of our most recent pricing date shows the distribution of convertible ranks in relationship to their underlying common stocks. Bear in mind that a convertible is never ranked if its underlying stock is not ranked. The chart below indicates that 587 (or 80%) of our universe of 739 convertible issues are indeed ranked based on the aforementioned variables. Another 152 issues were not assigned any rating because the company might not be covered in either of the Value Line Investment Surveys, and/or company-specific news affecting the basic fundamentals of the company. The chart also shows the breakdown of the distribution of ranks among the convertibles, and the corresponding common stock ranks. (Convertible ranks in columns going across and common ranks in rows going down.) For example, from the diagram we observe that 105 issues were assigned a 1 rank. The column shows further the number of convertibles in regard to their underlying stock rank. Incidentally, the Total Column to the right of the diagram shows a rank distribution pattern similar to the distribution pattern of the common stocks, where most of issues are convertible into average-ranked stocks.

Summary

It is clear that there is a high degree of correlation between the common and convertible ranks. However, several top-ranked convertibles are based on stocks that are not highly ranked. There also are many neutrally ranked convertibles based on highly ranked stocks. However, not all of these are especially recommended for purchase. And many unranked convertibles offer attractive returns, but we cannot recommend these issues. Our subscribers may use our database to find attractive bargains among unranked convertibles in our survey by comparing the reward/risk offered by convertibles.
Total Return of Rank 1 Convertibles vs. All Convertibles