The Value Line Convertibles Survey

Performance of Especially Recommended Convertibles in First Quarter 2008

Recession, or the fear thereof, was the general consensus of the investing population during the first quarter of this year. Even the chairman of the Federal Reserve Board, Ben Bernanke, acknowledged this possibility. The Bear Stearns debacle, and its eventual rescue by JP Morgan, sent an already weakening stock market into a tailspin, prompting the Federal Reserve to take action by cutting interest rates. Housing prices continue to fall, oil prices get higher, and financial companies are still mulling over the weakened condition of their books at the end of the first quarter. All major equity benchmarks were down. The Dow Jones Average fell 7.6%, the S&P 500 Index declined over 10%, and the NASDAQ Composite fell almost 15%. In this turmoil, convertibles did what was expected of them; they fell much less than their respective underlying common stocks.

For the quarter ended March 31, 2008, our Especially Recommended rank 1 convertibles were down 2.8%, while their underlying stocks retreated 12%; our All Especially Recommended convertibles lost 3.0% versus 12.3% for the underlying stocks; and our All Convertibles Total Return index was down 4.4%% for the first period.

How Convertibles are Chosen for Inclusion on Our Especially Recommended List

Each pricing period, our proprietary model assigns a rank, 1 (Highest) through 5 (Lowest), to convertibles whose underlying stock is ranked by either The Value Investment Survey or its sister publication, The Value Line Investment Survey Small and MidCap Edition. From the list of rank 1 convertibles (see page 5), we select issues that meet and/or surpass certain required criteria to be recommended for purchase. To be included in our Especially Recommended list, besides being ranked 1 (highest), a convertible must possess the following attributes:

1. A current yield advantage over its underlying stock, except in cases of zero coupon bonds or warrants.

2. Must be favorably leveraged. This means that they are expected to participate to a greater degree in an increase in the underlying common's price than in a decrease in the stock's price.

3. Should have some degree of call protection intact, or not considered a likely call candidate.

4. Easily traded. That is, the issue must be liquid to permit easy trading.

Note: Illiquid issues are sometimes included on our Especially Recommended list. Previously liquid issues can become illiquid, and therefore difficult to trade, as conversion takes place or issues are repurchased by the issuing company. Still, although illiquid issues are listed on our Especially Recommended table, we suggest investors avoid them.

Performance Results

For the March quarter, our All Especially Recommended Rank 1 convertibles recorded a loss of 2.8%, while their underlying common stocks fell 12%. As a group, our Rank 1 convertibles fell 1.8%, as stocks underlying these convertibles fell 12.3%. Our All Convertibles Total Return Index lost 1.8% for the quarter.

Especially Recommended convertibles are categorized into four different risk groups based on their Relative Volatility--an internal indicator of the level of risk in holding a convertible vis-à-vis its underlying common stock. The relative volatility of the stock is a measure of how risky that stock is in relation to the median stock in The Value Line Investment Survey universe of over 3,500 stocks. Our High Risk group consists of warrants only, and has the highest profit potential. The Above Average Volatility group carries convertibles with Relative Volatility of 95% and above, with above-average profit potential. The Modest Volatility (moderate profit potential) group has convertibles whose Relative Volatility is between 65% and 90%, and the Low Volatility (modest profit potential) group has convertibles whose Relative Volatility is 60% and below. Performance in these groups was mixed. Our best performance during the quarter was turned in by rank 1 convertibles in the Modest Volatility -- Moderate Profit Potential group-- the group lost a mere 0.8%. The Above Average Profit Potential group fell 4%, and the Low Profit Potential group declined 2.8%. These results are posted in Figure 1 on page 34.

We advise investors to purchase our recommended issues (when they are ranked 1), hold when the rank drops to a 2, and sell if the rank falls further (to 3). Therefore, we also evaluated the performance of our entire portfolio of recommended issues. Again, the best-performing group for the quarter was the Modest Profit Potential with 5 convertibles, down 1.4%, while stocks underlying these issues were down 13% on average. The Above-Average Profit Potential group lost 1.9%%, and the Low Volatility— Modest Profit Potential group slid 3.3%. Underlying common stocks were down 4.1% and 13.2%, respectively. The High Risk (warrants) category recorded a loss of over 40%. See these quarterly performance results on page 35 (Figure 2).

Liquid vs. Illiquid Issues

Although recommended convertibles are carefully chosen, we sometimes include relatively illiquid issues—those that are difficult to trade-- because of their attractiveness. Also, liquid issues can become illiquid due to partial redemption, early conversion, or repurchase. Rarely, however, do illiquid issues offer a true performance advantage, even if it appears so by results. In cases where the actual trading price and volume on a convertible are unavailable (which is often the case with illiquid issues), performance results will reflect price quotes that represent the midpoint between the bid/ ask spread, and illiquid issues often trade at wide bid/asked spreads. If an investor buys an issue at the asked price and sells it at the bid, such wide spreads will dramatically reduce the profit potential these issues appear to possess on paper. Still, for those investors who might be interested in pursuing illiquid issues, Figure 3 on page 34 compares the returns of both liquid and illiquid issues, and combined as a group.

Conclusion

Our performance results underscore the defensive nature of our portfolio. The 4.0% lost from rank 1 convertibles in the Above- Average group, where above-average profit was expected, underperformed rank 1 convertibles in the Low Volatility—Modest Profit Potential group, which lost 2.8%. These results serve only as an indication of how investors would fare following our recommendations at the quoted trading levels. Invariably, some convertibles are inaccurately quoted, and prices do change at the point of purchase. This would have an impact on the performance results of individual portfolios, plus commission costs and other expenses are not taken into consideration. Furthermore, constant maintenance of such a model portfolio like ours would more than likely offset some of the perceived gains. While past results are no guarantee of future performance, the Value Line's convertible ranking system (which weighs such key factors as the attractiveness of the underlying stock, the convertible's yield advantage over the common, its investment value, as well as some inaccuracy in pricing the convertible) has proven effective over the years. We are confident that our proprietary model will continue to discriminate effectively among our universe of convertible securities, giving subscribers/investors an edge in the convertible market.

Prepared by
George S. Graham Editor