Added to Watch List: Pulte Homes Exchange Traded Bond (PHA)
(UPDATED)
In a prior post I mentioned low-quality bonds that were beaten-down in the last few months. My contrarian impulses have made me to look at homebuilder bonds (I also thought about bonds of Abitibi Consolidated--a stock I'm thinking of investing in). There are a lot of bonds one can invest in but I am limiting myself to exchange-traded bonds. For those not familiar, these are bonds that trade on an exchange, whereas the vast majority of bonds do not trade on an exchange (this is also what makes bonds unattractive to small investors). With an exchange traded bond, you will buy/sell as if it were an ETF or stock. I have previously held one of the exchange-traded bonds of General Motors (symbol: GMS).
The one that caught my eye is the Pulte Homes 7.375% Senior Notes due 6/1/2046 (symbol: HMA). You can get more information from the best free bond investing site on the planet: Quantum Online (if you are interested in bonds, you should bookmark this site. You need the free registration for the detailed stuff). These bonds are trading around 20% below par so you have a capital gains potential of around 20%. The yield is around 9% right now. Before I invest, I would want to check to see the financial condition of Pulte Homes to make sure it is not going to go bankrupt or default on the bonds. I took a quick glance and it seems like Pulte can pay the bonds (I ruled out Abitibi because there is a small possibility of them defaulting, and when I owned GMS, GM had a high chance of going bankrupt or defaulting (GM's debt to equity was a scary number ;) )).
So one is looking at around 9% yield plus a 20% capital gains potential. In the worst case, that capital gains will be spread out over 40 years :)If one thinks that Pulte can rebound in 3 years, then you will likely earn around 5% per year in the capital gains to generate a total of 14% per year for three years.
Returns on junk bonds
One of the hardest things for a newbie investor like me is that I'm still not sure what is an appropriate return on an investment. I used to think that I should be aiming for 20%/year but after being influenced by Warren Buffett, Charlie Munger, and others, I'm not really sure. I am totally and utterly confused. Given that the stock market returns 10% per year in the long run, is 12% per year a good return? I don't know if investments like these (if I decide to go for it) will hurt my portfolio or help it.
Is it worth pursuing a junk bond or go for the underlying stock? It's a hard decision. In the case of GM, I went with the bond because I felt there was a small risk of the company going bankrupt (although you will take losses on the bonds, bondholders will likely have been issued new shares post-bankruptcy and they typically do ok) and I thought GM would post big losses if the economy slowed down (whereas bondholders would have been paid the interest (yield was something like 11% on those bonds when I bought)). In the case of the Pulte Homes, I do not see bankruptcy on the horizon and the stock looks way more attractive than the bonds.
One attractive feature of junk bonds is that they have low correlation to the broad markets. Since I am bearish on the markets (due to my expectation of an economic slowdown), junk bonds are attractive. However, I should note that companies issuing junk bonds generally run into financial difficulties when the economy slows, so these bonds will only be attractive if you do not think the company will default. This default scenario doesn't apply to me because, although I would consider that in determining risk and return before purchase, I would clearly not buy a bond if I thought there was a chance of default.
An investor should also consider the tax implications. These bonds can be quite unattractive from a tax point of view. I'm a small investor and taxes aren't that big of a deal yet (eg. commissions and bid-ask spread is a bigger problem for me) so I don't pay as much attention to them.
In any case, I am still not sure I like this idea but if the price drops, I will look at it. I would like to see the bonds trading at around 60% of par value to make them really attractive. Right now they are around 80% of par value.
UPDATE: I noticed that PHA is rated Baa3 by Moody's with a potential ratings downgrade since August 22, 2007 (S&P rates it as BBB-). Both of these are just above the non-investment-grade level so a downgrade by Moody's will put that rating into the non-investment-grade (i.e. junk bond) territory. Should this happen (likely given how badly the housing situation is deteriorating) then some funds that cannot hold junk bonds may be forced to sell. I think PHA is worth investing during such time.
In a prior post I mentioned low-quality bonds that were beaten-down in the last few months. My contrarian impulses have made me to look at homebuilder bonds (I also thought about bonds of Abitibi Consolidated--a stock I'm thinking of investing in). There are a lot of bonds one can invest in but I am limiting myself to exchange-traded bonds. For those not familiar, these are bonds that trade on an exchange, whereas the vast majority of bonds do not trade on an exchange (this is also what makes bonds unattractive to small investors). With an exchange traded bond, you will buy/sell as if it were an ETF or stock. I have previously held one of the exchange-traded bonds of General Motors (symbol: GMS).
The one that caught my eye is the Pulte Homes 7.375% Senior Notes due 6/1/2046 (symbol: HMA). You can get more information from the best free bond investing site on the planet: Quantum Online (if you are interested in bonds, you should bookmark this site. You need the free registration for the detailed stuff). These bonds are trading around 20% below par so you have a capital gains potential of around 20%. The yield is around 9% right now. Before I invest, I would want to check to see the financial condition of Pulte Homes to make sure it is not going to go bankrupt or default on the bonds. I took a quick glance and it seems like Pulte can pay the bonds (I ruled out Abitibi because there is a small possibility of them defaulting, and when I owned GMS, GM had a high chance of going bankrupt or defaulting (GM's debt to equity was a scary number ;) )).
So one is looking at around 9% yield plus a 20% capital gains potential. In the worst case, that capital gains will be spread out over 40 years :)If one thinks that Pulte can rebound in 3 years, then you will likely earn around 5% per year in the capital gains to generate a total of 14% per year for three years.
Returns on junk bonds
One of the hardest things for a newbie investor like me is that I'm still not sure what is an appropriate return on an investment. I used to think that I should be aiming for 20%/year but after being influenced by Warren Buffett, Charlie Munger, and others, I'm not really sure. I am totally and utterly confused. Given that the stock market returns 10% per year in the long run, is 12% per year a good return? I don't know if investments like these (if I decide to go for it) will hurt my portfolio or help it.
Is it worth pursuing a junk bond or go for the underlying stock? It's a hard decision. In the case of GM, I went with the bond because I felt there was a small risk of the company going bankrupt (although you will take losses on the bonds, bondholders will likely have been issued new shares post-bankruptcy and they typically do ok) and I thought GM would post big losses if the economy slowed down (whereas bondholders would have been paid the interest (yield was something like 11% on those bonds when I bought)). In the case of the Pulte Homes, I do not see bankruptcy on the horizon and the stock looks way more attractive than the bonds.
One attractive feature of junk bonds is that they have low correlation to the broad markets. Since I am bearish on the markets (due to my expectation of an economic slowdown), junk bonds are attractive. However, I should note that companies issuing junk bonds generally run into financial difficulties when the economy slows, so these bonds will only be attractive if you do not think the company will default. This default scenario doesn't apply to me because, although I would consider that in determining risk and return before purchase, I would clearly not buy a bond if I thought there was a chance of default.
An investor should also consider the tax implications. These bonds can be quite unattractive from a tax point of view. I'm a small investor and taxes aren't that big of a deal yet (eg. commissions and bid-ask spread is a bigger problem for me) so I don't pay as much attention to them.
In any case, I am still not sure I like this idea but if the price drops, I will look at it. I would like to see the bonds trading at around 60% of par value to make them really attractive. Right now they are around 80% of par value.
UPDATE: I noticed that PHA is rated Baa3 by Moody's with a potential ratings downgrade since August 22, 2007 (S&P rates it as BBB-). Both of these are just above the non-investment-grade level so a downgrade by Moody's will put that rating into the non-investment-grade (i.e. junk bond) territory. Should this happen (likely given how badly the housing situation is deteriorating) then some funds that cannot hold junk bonds may be forced to sell. I think PHA is worth investing during such time.
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