Mining Warrants for Dummies
As investors reflect on this current pullback in the precious metals stocks and warrants, perhaps this is a good time to continue our educational discussions on the advantages and disadvantages of owning warrants.
First, let us not lose site of our overall views and objectives. Are we not in a long-term bull market? Are we not anticipating gold prices to exceed the previous highs of January 1980 as many analysts are now predicting possibly this year? So, let's take a deep breath, be happy for our gains to date and use this time to "build our inventory" of stocks and warrants for the next up- move which we believe will come sooner than many believe.
Our personal philosophy is to "build inventory" which (to us) means we are not interested in trading but rather in holding and increasing our positions on pullbacks. Yes, the day will come when it will be time to exit the party, but we do not see that happening soon. So we look for new opportunities everyday in mining stocks and warrants as a means of participating in these markets and we will take the pullbacks and rallies as they come.
Warrants for Dummies
Well, we can all continue to learn, can we not? Even many of the "big boy" analysts (we believe) do not fully comprehend warrants and their place in one's portfolio, and few analysts we follow (which are many) never provide any comments or advice with respect to warrants trading on stocks in their recommended portfolio's. Why not? Good question! One newsletter that does comment on warrants does so with a negative connotation so as to discourage an investor from even pursuing this investment opportunity. Why? We believe this is not intentional but just not giving investors all the facts.
So, what is a warrant? Where do they come from? Why would an investor want to purchase them? What is this term called 'leverage'? How and where do they trade? Don't warrants have a dilution effect on the company's common stock? Can I lose money by purchasing warrants? Many great questions which we will briefly discuss to educate investors as to the advantages and, yes, possible disadvantages of warrants.
A warrant is a financial instrument which gives you, the investor, the right, but not the obligation, to purchase the underlying common stock of a company at a specific price and expiring on a specific date in the future.
Warrants are issued by a company in connection with a private equity financing arrangement, a sale of additional stock in the company, or on the company going public. The warrants are frequently referred to as an "equity kicker", i.e., an additional incentive for the purchaser of the common stock to invest in the company. Most of the warrants issued by companies are never traded and remain privately held by insiders and institutional investors. Fortunately, there are many warrants which are currently trading in the United States and Canada for investors to consider for purchase. Many of the warrants are issued for a two year period, but some now are being issued for a period of up to five (5) years. In effect, warrants are a long term call on the potential price increase of the common stock.
Warrants provide the investor the potential for incredible upside leverage versus the underlying common stock. Think about it. If the underlying common stock doubles, triples, etc. would not a warrant on this company perform better? Remember, a warrant has a specific expiration date and exercise price and as the price of the underlying common stock rises (remember, we are in a bull market) the warrant will (in most cases) greatly out perform the common stock.
Many times the warrants will reflect the potential of a 2:1 leverage over the common stock, meaning simply, if the common stock increases 100%, the warrant will increase by 200%, thus a leverage of 2:1. So, to us, leverage means getting the maximum return with the least amount of your capital at risk.
So, if your favorite newsletter writer or analyst, in their recommended stock portfolio, include companies that have warrants that are trading should you not at least consider the purchase of the warrants in lieu of the common stock? We ask, why not?
Unlike options, warrants trade exactly like the underlying common stock. No special paperwork to fill out or additional requirements by investors. They are assigned a trading symbol and can trade on the NYSE, AMEX, NASDAQ, or in the Over-The-Counter market. As many of the warrants trading are on Canadian mining companies, these warrants are assigned a symbol so the trade can be performed in the Over-The-Counter market in the United States.
Dilution Effect : Isn't it true that if a company has warrants outstanding that this will have a dilution effect on the capitalization and earnings of the company? Of course! As any accountant fully understands if the warrants are eventually exercised there will be more shares outstanding and thus a dilutive effect will occur.
However, are not investors looking for a bigger picture, a bull market, if you will, that will take the company's shares much higher? If so, the warrants, as explained previously, will out perform the common shares. We believe many of
the companies with warrants trading will continue to acquire additional properties and increase reserves thus bringing additional value to the company and offsetting some, if not all, of the dilutive effect.
The point here is that if an analyst is recommending the purchase of a company's common stock or an investor is contemplating the purchase of a company's common stock should you not first ask the question: does this company have any warrants currently trading; how much time remains on the warrants until they expire, and what is the leverage potential?
Lastly, if the common stock is trading under the exercise price at the time the warrant expires then the warrant will be totally worthless. That is never a good thing!
Investors should always discuss with their brokers or investment advisors whether warrants have a place in their investment portfolio, remembering that you may have to educate your broker or investment advisor as to exactly what a warrant is.