As per Mr. Graham, convertibles are smaller into the risk compared with the common stock of the same company. We also know that preferred stockholders get first preference compared to the common stock for dividend/interest and also at liquidation. Convertibles are more related to common stocks rather than debt instruments.
But always a question that when to sell convertibles? Should we opt for the conversion to common stock? Or keep on holding a bond and getting interested in it?
When the company is doing well, growing more than a cost of capital, generating higher return ratios, then it is advisable to hold convertible and let them getting convert to common stock.
If the company has an average performance, average return ratio, no clue for potential decent growth then it is advisable to hold convertible and keep getting interested in it.
Generally, warrant or stock option are not recorded under the common stock capitalization and also, EPS is shown without an impact of it. So that we need to add those warrant or the stock option to the outstanding equity shares and consider EPS. Company issues warrant when they require a capital, prepayment of bond / preferred stock, etc. But this is not a suitable way to raise capital. If a company wants to issue a common stock then they need to directly issue to shareholders on the prevailing market price rather issue a warrant on the below market price. This will result in more dilution of equity compared to the issue at a higher price.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig
