Keep This Hybrid in Mind If You’re Seeking Income

An overlooked source of income in the Canadian market that you should stick in your tool kit.

The Motley Fool

With bond yields bouncing along at historical lows, credit spreads reasonably tight, and dividend paying stocks bid into the top valuation tier, Canadian investors are running out of attractive ways to get their income fix.  An option that is often times overlooked is the convertible debenture.

What’s that?

A convertible debenture is sort of a hybrid between a corporate bond and a stock.  When first issued, they look like a bond.  There is a regular coupon, a maturity date, and the issue price is typically par.  However, strapped to this ordinary looking bond is an equity-linked conversion option.  This gives the owner the option to “convert” the bond into the company’s stock at a pre-determined exchange ratio, if the price of the stock climbs to a certain level.

The security effectively blends the security of a bond with the upside of an equity.  As long as you’re buying into a financially sound company, the worst that you will do with a convertible debenture is receive a regular coupon payment and get your money back at the maturity date.

However, if the company’s stock takes off and exceeds the conversion price, you will participate on the upside.  The debenture’s price will tend to move with the stock once the conversion price is cleared.  This is known as being “in the money”.  Limited downside and upside optionality are welcome attributes with any investment.

Sounds too good to be true

Theory and practice aren’t necessarily aligned in the Canadian convertible bond market.  The downside protection is legit, again, as long as you’re dealing with a financially sound entity.  The optionality provided by the conversion feature is slightly less so.  Many of the convertibles in the Canadian market trade with a very wide gap between their current stock price and the conversion price.  On average, this gap is 112%, however, outliers have a significant impact on this figure as the median difference is only 32%.  Selection is important if you want that upside kick.

How do I buy these things?

Convertible debentures trade on the TSX just like an ordinary stock.  There is no magic involved with transacting in them.  Typically they have a “.DB” added to the ticker symbol of the underlying equity.  XYZ.DB for example.

There is some magic involved in knowing which companies offer this kind of security, but the National Post appears to offer a comprehensive list here.

The Foolish Bottom Line

Canada does not have a very well-developed corporate bond or high yield debt market.  Income trusts served this purpose for many years.  With the disappearance of trusts, convertible debentures are likely to play an increasingly important role in this country’s capital markets.  You’ll be ahead of the game and ready to profit if you begin following these hybrids before they truly go mainstream.  In our next post, we’ll have a look at 2 convertible debenture ideas to help get you started. 

Follow us on Twitter and Facebook for the latest in Foolish investing.

Fool contributor Iain Butler does not own shares in any of the companies mentioned in this report at this time.  The Motley Fool has no positions in the stocks mentioned above.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Oil pumps against sunset
Energy Stocks

Is it a Good Time to Buy in the Energy Sector?

Boosted by a very bullish supply/demand environment, energy stocks like Canadian Natural Resources and Tourmaline have much further to go.

Read more »


2 Stocks to Buy Offering Better Value Than Air Canada

Air Canada has been a popular stock for years, but despite its low price, these two picks are much better…

Read more »

money cash dividends

How to Make $373/Month in Passive Income With These 2 TSX Stocks

You could bring in passive income of $4,482 annually, or $373 per month!

Read more »

clock time
Stocks for Beginners

3 Stocks to Start Investing Today

Looking for a set of stocks to start investing today? Here are some great options that offer growth and income…

Read more »

investment research
Dividend Stocks

Young Investors: Create Cash Flow With This Top Dividend Stock

If you're a young investor looking for cash flow, you need a strong dividend stock and solid banking program designed…

Read more »

Illustration of bull and bear

Is the Stock Market Selloff Over?

Throughout this week, many stocks have been gaining value and rebounding from their lows. So, is the stock market selloff…

Read more »

potted green plant grows up in arrow shape

Retirement 101: How Investors Can Turn $20,000 Into $500,000 in 25 Years

These top TSX dividend stocks have made some investors rich.

Read more »

Hand writing Time for Action concept with red marker on transparent wipe board.
Dividend Stocks

3 Superb Dividend Stocks I’m Ready to Buy

The market is full of great options for income-seeking investors. Here are three superb dividend stocks to buy now.

Read more »