Warren Buffett’s Letter – 1990 (Part 5)
Dec 9th, 2006 by Martin Lee
Convertible Preferred Stocks
Warren Buffett values convertible stocks by looking at three things: interest rates, credit quality and prices (or more precisely, valuation) of the related common stocks.
He warns against inaccurate or misleading valuations by others. For example, several members of the press calculated the value of all their preferreds as equal to that of the common stock into which they are convertible.
By their logic, Warren’s Salomon preferred, convertible into common at $38, would be worth 60% of face value if Salomon common were selling at $22.80.
The problem with using this valuation is that all of the value of a convertible preferred would reside in the conversion privilege and that the value of a non-convertible preferred would be zero, no matter what its coupon or terms for redemption.
This does not make any sense at all.
The correct way of valuing convertible stocks is to firstly look at their fixed-income characteristics. Then, you look at the conversion option and see whether it adds additional value to the basic fixed income valuation.
What this means is that the securities cannot be worth less than the value they would possess as non-convertible preferreds.
What happens if Warren Buffett Dies?
Warren candidly mentions three things that would happen if he passes away suddenly:
“(1) None of my stock would have to be sold; (2) Both a controlling shareholder and a manager with philosophies similar to mine would follow me; and (3) Berkshire’s earnings would increase by $1 million annually, since Charlie would immediately sell our corporate jet, The Indefensible (ignoring my wish that it be buried with me).”
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