This summer, Warren Buffett announced that his company was cashing in “free shares” and turning a quick $12 billion profit.
Normally off limits, these special shares can offer big upside for their investors. One situation is NOW OPEN to early investors; click here for details.
Back in 2011, Warren Buffett made a $5 billion investment in struggling Bank of America (NYSE: BAC).
Buffett’s company, Berkshire Hathaway (NYSE: BRK-B), bought preferred stock that paid a 6% annual dividend.
Those preferred shares included a stock warrants. A warrant allows the owner to acquire stock at a pre-determined price for a specified period of time.
In the case of Buffett and Bank of America, the warrants allowed Berkshire to buy 700 million common shares of Bank of America stock at a price of $7.14. And Berkshire could “execute” the warrants any time before expiration in year 2021.
At the time, the warrants weren’t worth much. The stock was trading around $7 at the time of the deal. Therefore, converting them into common stock didn’t make any sense back in 2011.
Buffett Exercises Stock Warrants
Fast forward six years, and Bank of America stock is trading in in the mid-$20s.
In late June, Buffett announced that he would exercise the stock warrants.
This essentially allowed Berkshire Hathaway to pay $7.14 for a stock that was now trading for over $24.
The total payout? A cool $12 billion.
Now, Warren Buffett has unusual access to special deals like that with Bank of America. For example, you and I never had a shot at those preferred shares that Berkshire Hathaway purchased.
That’s one reason why I like owning Berkshire Hathaway stock: Buffett occasionally gets offered amazing deals just like this.
Most people have never owned warrants. But they’re an amazing investment that can multiply your total return.
These securities are often used in private placements transactions or secondary stock offerings.
How Stock Warrants Work
A privately held company is offering to sell shares in a financing before going public.
Each of those “units” is priced around $2 . . . and a unit includes 1 share of common stock and 1/2 of a warrant.
Those warrants can be converted into common stock at the same price, any time in the next three years.
Why include warrants? It’s a way to incentivize investors to take a chance on an investment in a private company. It’s something extra to help encourage investors to take on some risk.
For the company, these warrants are also a positive: When the warrants are executed and converted into common stock, the company gets paid the cash for the purchase price.
These warrants simply provide greater investment upside, with no additional risk. For example, the warrants don’t “cost” anything, unless they are converted into common stock. And the only time you’d convert the warrant is when the stock price is above the conversion price.
Let’s take a look at how this would work.
Let’s say you invested $5,000 in a private deal, buying “units” at $2. Each unit includes one share of common stock and 1/2 warrant.
So, you’ve got 2,500 shares of common stock and 1,250 stock warrants that can convert into common stock at $2.
The private company then goes public in an IPO. And let’s say the stock price doubles within the next three years to $4 per share.
At that point, the 2,500 common shares are worth $10,000.
Meanwhile, the “free” warrants can now be converted at $2 and immediately sold for $4. So, they deliver a quick profit of $2,500 as well.
The stock warrants simply let you multiply your profits by 50%.
One private Canadian company is preparing to go public. But along with the IPO, they’re doing a special financing that includes stock warrants. And they could offer considerable upside.