Understanding Stock Warrants
July 16, 2014
Dudley Pierce Baker
If you don't understand stock warrants, you are not alone. Very few of the professional newsletter writers and analysts understand them so why should you?
Allow me to give you a brief education on stock warrants in the following paragraphs and tell you exactly why you need this information.
Did you know that warrants have been in existence and trading for many decades but very few investors know about them? Why? Are warrants that difficult to understand? Of course not, it's just that one needs to take some time to learn and understand this incredible investment vehicle.
To put this discussion in perspective, I would like to offer a quote from the past,
"...Common stock warrants turn in the most spectacular performance of any group of securities....the speculative potentialities of common stock warrants are enormous....
With potential profits and potential losses so great it is a source of wonder that so little understanding of the nature of common stock warrants exists not only among the investing 'public', who might be forgiven this sin, but even among the many 'professionals' of the business upon whom the 'public' depends for information and guidance."
Sidney Fried, 'The Speculative Merits of Common Stock Warrants', 1949.
Did you get that? 1949. As stated in the above opening paragraph, the public and professionals today are, for the most part, not aware of the enormous profit potential of warrants and thus absolutely nothing has changed since Sidney Fried's comments in 1949.
In the 1960's and 1970's Sidney Fried had a service called, 'The RHM Warrant Survey' to which many investors subscribed and which was available only in hard copy. To the best of our knowledge, this service stopped in the late '70's or early 80's and very little information has been available since to investors, until recently.
Currently there are approximately 200 stock warrants trading on the NYSE, OTC, Toronto Exchange and Toronto Venture Exchange. There are stock warrants trading on virtually all industries and sectors, i.e., resource companies, financial services, gaming, autos, banking, biotechnology, restaurants, etc.
Approximately one-third of the stock warrants trading in today's markets are on the common shares of the natural resource and commodities companies. As we are still in a bull market in this sector (believe it or not), investors are constantly looking for new ways to invest with the potential for great gains. These precious metals companies which have warrants trading give investors exposure to gold, silver, uranium, zinc, copper, cobalt, platinum, oil & gas, etc.
Stock warrants are but one of the many vehicles to consider along with gold bullion, gold coins, ETF's, mutual funds, options, LEAPS and common shares of the mining companies.
So with this background, let me give you a brief introduction to warrants.
A warrant is a security (similar to a call option) giving the holder the right, but not the obligation, to purchase the underlying stock at a specific price and expiring on a specified date in the future. Sounds very much like a call option or LEAP, doesn't it?
Stock warrants are issued by a company usually in connection with a private placement or a financing arrangement and many of the warrants issued will remain privately held and will never trade in the open marketplace but those that trade are the focus of our attention.
So, why the interest in warrants? The owner of the warrant receives none of the benefits of ownership of the common stock of a company. He cannot vote, and he does not receive any cash dividends. Therefore, why would an investor want to buy an option (warrant) to buy something instead of buying the thing itself?
The essence of the answer is that the anticipated gain on the warrant must be greater than the anticipated gain on the common stock. Leverage, or at least potential leverage, is the prime reason an investor would be interested in warrants. This more rapid growth in the value of the warrant relative to the common stock is called leverage. Without this possibility of such leverage the investor would buy the common stock. A good rule of thumb is to seek out those stock warrants having the potential to greatly outperform the shares with a desired leverage of 2 to 1 or better.
Currently there are many warrants trading with expiration dates out to the year 2017 (one out to 2030) and though warrants expiring within, say, two years, may possess great upside leverage and potential for gains, they also pose a greater risk. Therefore, we personally suggest that investor's focus their attention on those warrants that have a remaining life of at least two years before their expiration.
As with any investment each investor must decide how much of one's portfolio to allocate to different sectors, different shares, ETF's, mutual funds, gold bullion, etc.
Even though we personally view 'long-term warrants' as investments (as opposed to speculation), an allocation of 10% to 15% maximum of your portfolio would be a reasonable allocation of your total dollars to this investment vehicle.
To summarize, an investor may wish to purchase a stock warrant that is the option (the right) to purchase the common stock of a company. Investor's may prefer to purchase the warrant instead of the common stock because the warrant offers more potential gain, that is, the warrant offers the investor leverage. Using a portfolio allocation of 10% - 15% and buying long-term warrants on some of your favorite shares, you are now in the position to capture some incredible potential gains as this bull market in the natural resource and commodity sectors reasserts itself over the next two to three years.
For those investors seeking more knowledge on warrants we invite you to sign up for our free emails and visit our Learning Center where we provide you much more information and examples to enhance your learning experience.
Disclosure: Neither Dudley Pierce Baker nor CommonStockWarrants.com is an investment advisor and any reference to specific securities does not constitute a recommendation thereof. CommonStockWarrants.com is an online newsletter providing complete details on all stock warrants trading in the United States and Canada. The information and opinions expressed should not be construed as a solicitation to buy and securities mentioned in this service.