Very few investors know about the potential benefits via the additional leverage that warrants can offer [but they are substantial if you follow the 4 rules I present in the article below]. Words: 766
So writes Dudley Baker (CommonStockWarrants.com) in edited excerpts from his original article entitled The Secret of Investing With Stock Warrants.
[The following article is presented by Lorimer Wilson, editor of www.munKNEE.com and has been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Baker goes on to say in further edited (and perhaps paraphrased in some instances where warranted) excerpts:
What Is A Warrant?
A warrant is a security giving the holder the right, but not the obligation, to purchase the underlying security at a specific price and expiring on a specific day in the future. A call option would be defined very similar, except an option would be created/written by an investor where as a warrant originates from the company and the options will always have much shorter lives, usually 90 days to 1 year.
Did you know that virtually every company has some outstanding warrants in their capital structure? Since the 1920s warrants have been issued in connection with initial public offerings and financing arrangements in which investors or the acquiring companies are seeking more leverage and thus warrants are viewed as an ‘equity kicker’ in those transactions.
Types of Warrants
1. Private Placement Warrants: The warrants of most companies were issued in connection with a private placement and thus will never trade. Yes, a few investors will have the financial ability and legal opportunity to participate in a private placement in the resource sector but those offerings by U.S. companies outside of the resource sector give little opportunity for investment.
Savvy investors like Rick Rule and Warren Buffett would never participate in a private placement without receiving warrants with at least two (2) years before expiration and many times substantially longer.
2. Trading Stock Warrants: Few investors are aware of the fact that today there are 183 stock warrants which are trading on the Toronto Exchange, Venture Exchange as well as on the NYSE and Nasdaq. These trading stock warrants are bought and sold just like buying or selling common shares and is done through your regular brokerage firm.
From our view, the standard was set by Sidney Fried in his 1950s thru 1970s service, “The RHM Warrant Survey” and his many books written on the subject, all of which we own and have studied for many years.
Rules for Successful Warrant Investing
1. Find a company you like
This is perhaps the most important factor because if the company does not perform and execute on its business plan the common shares will not rise.
Investors now have many opportunities with stock warrants in the resource sector as well as in other sectors, for example, gaming, banking and financial services, autos, oil & gas, biotech, pipelines and more.
2. Identify the time to buy
Currently the equity markets are on fire with the Dow and the S&P 500 near all time highs. In the resource sector the shares have been beaten down badly and offer great upside opportunity, in our opinion. Ultimately, you as the investor must make the decision as to which company and when to buy.
3. Choose a long-term warrant
The longer the remaining life of a warrant the better giving the company more time to execute on their business plan and more time in the event of a market downturn. Your minimum time horizon should be no less than two years of remaining life when you purchase the warrants. Many of the warrants have over 3 years remaining and one of the most recently issued warrants does not expire until 2030.
4. Identify a warrant currently priced to deliver leverage of at least 2-to-1
Remember, investors are buying stock warrants for their additional leverage over the common shares, thus you should be looking for a minimum of a 2-to-1 return, meaning if the common shares increase 100%, the warrants should increase 200%.
Risk is always a factor in investing and one should remember that while warrants can offer exceptional upside leverage over the common shares, if the common shares are selling below the exercise price on the date of expiration, the warrants are worthless. [As such, if the company’s common shares and are not performing well, one would be well advised to sell the stock warrants just as you would sell the common shares well in advance of the expiration date.]
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
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