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April Idea of the Month: Betting on 2018

By Travis Johnson, Stock Gumshoe, April 12, 2013

I’ll be traveling for most of the next week, so we’re getting this Idea of the Month note out to you on Thursday night/Friday morning, a bit early. There will not be a Friday File or much else in the way of new content at Stock Gumshoe next week, but I will provide at least a quick update for the Irregulars in a delayed Friday File on Monday, April 22. Have a great week!

We’re now five years past the real jump-start of the last financial crisis — what will the world look like in another five years? If you’re at all optimistic about the United States, and think our economy will be largely “normal” for the next half-decade, then you have an opportunity to get substantial leveraged returns from bank warrants.

We’ve talked about warrants before — we’ve enjoyed more than a double in our ROIC warrants in less than a year, for example, and I’ve covered the warrants of a few small resource companies before (I’ve most recently suggested, in past weeks, that the warrant restructuring at ROIC makes them a bit riskier going into their earnings release, which will be on May 2 — I’ve taken much of my profits on those but will hold the rest through the earnings release to see how they change their forecast to incorporate the dilutive effect of the partial warrant exercises).

Warrants are often used to give investors in risky startups or junior companies a “sweetener” … a way for them to get not only their equity position, or their bond or preferred stock coupons, but also to benefit if the company does particularly well. Most of the time, warrants are good for a few years, maybe 3-5 years on average, but the government demanded an unusually strong “sweetener” from the banks it had to rescue during the financial crisis, so their TARP rescue funds came along with not just the requirement to repay the loans or pay nice coupons on preferred stock, but 10-year warrants to let taxypayers benefit if the banks started rolling in money again.

For whatever reason, the gummint didn’t decide to hold on to all these warrants — so they auctioned them off, some were bought back by the companies themselves and some, when the company didn’t want to buy them back or wouldn’t pay a fair price, were sold into the market, and ...

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