I recently posted a "StockTalk" on Seeking Alpha that included a link to my article, "Toll Brothers' Newly Issued Bonds Are Worth a Look." The article provides a bit of background on Toll Brothers (NYSE:TOL) and highlights the company's newly issued 10-year, 5.625% coupon notes (CUSIP 88947EAQ3).
In response to the StockTalk, one reader wrote the following: "ytm of 5.51% for a duration of 7.70 looks interesting only IF Treasuries STOP falling." That viewpoint is certainly one I imagine others hold as well. But I would also like to point out something other than duration and the potential for mark-to-market price declines that I focus on when shopping for individual bonds. The following two questions help illustrate the point:
1. Assuming the credit risk is appropriate for your portfolio, does a bond's yield provide a "real" rate of return?
2. Assuming the credit risk is appropriate for your portfolio, does the yield being offered help you achieve your portfolio's income-generation goals better than other securities you are currently considering?
When the answer to both these questions is "Yes," and you are an individual bond investor who makes purchases with the intent to hold the bonds to maturity, I think it is perfectly acceptable to brush aside concerns about a bond's duration and concerns about potential future mark-to-market price declines. In fact, if you determine a bond is suitable for your portfolio from both a credit risk and yield perspective, and you have the wherewithal to hold that bond to maturity, I contend that allowing the bond's duration or the potential price moves of Treasuries to influence your purchasing decision is not a financially-responsible thing to do.
For those who disagree, I would simply remind them that most investors typically buy bonds for income, not for capital appreciation. If your investment objective is capital appreciation, stocks might be more suitable for you. If, however, your investment objective is not capital appreciation, and you are buying an individual bond that you intend to hold to maturity, why would you concern yourself with duration?
To rephrase the quote mentioned above, a 5.51% yield-to-worst looks good if you think the credit risk is appropriate, you have the wherewithal to hold the bond to maturity, and the yield provides you a real rate of return that helps you meet your income goals. As far as duration goes, simply manage your liquidity properly and leave duration worries to bond fund investors.
Finally, for those investors interested in purchasing Toll Brothers' January 15, 2024 maturing, Ba1/BB+ rated notes, let me emphasize one risk in particular. The notes have a "Special Mandatory Redemption" at par in the event the purchase of Shapell Industries' single-family residential property business is not completed prior to May 31, 2014. Given the notes are now trading slightly above par, this is a risk about which you should be aware.
Additional disclosure: I am long Toll Brothers' CUSIP 88947EAQ3.