I’m Back to Buy More Bank of America Corp Warrants

In the wake of Bank of America's (NYSE: BAC  ) $17 billion settlement with the U.S. government, my Special Situations portfolio is buying more warrants on this megabank. The warrants offer huge leveraged upside on the return of a normal economic environment, and with the bank already undervalued, they should easily return 20% annually until expiring in 2019.

I last purchased Bank of America warrants in early August, and today with the $17 billion settlement in the rearview mirror, there's even more reason to like the company. The year ahead looks great. Analysts project $17 billion in earnings, putting the stock at just 10 times next year's earnings. That prices in almost no growth. Then we're stacking the leverage power of warrants onto the trade for an extra boost.

And the bank has a huge vote of confidence from one of the world's top investors. Warren Buffett owns his own special class of warrants (with a strike price of $7.14) to buy 700 million shares of the company. If the warrants were exercised, Buffett's company would become the largest shareholder of Bank of America.

The bank just initiated a quarterly dividend of $0.05 per share. The warrants allow holders to capture this dividend in the form of a lower strike price. For dividends in excess of $0.01 per quarter, the surplus reduces the strike price by an equivalent amount. The starting strike price for the warrants is $13.30, so for now each quarterly dividend should lop off $0.04 from that strike.

In future years, I expect increased dividends to bring down that strike price even more. Further dividend increases in later years could really juice the return here. For more on the warrants, follow me on Twitter: @TMFRoyal. And check out my dedicated discussion board.

Foolish takeaway
My Special Situations portfolio is buying more Bank of America warrants, adding another $500 to my position. I think 20%+ annual returns are a real possibility here.

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Read/Post Comments (6) | Recommend This Article (11)

Comments from our Foolish Readers

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  • Report this Comment On August 26, 2014, at 3:20 PM, Mliaom wrote:

    Hi Jim,

    How exactly do you buy warrants? Is it like buying calls?

    Thanks for everything.

    Tony

  • Report this Comment On August 26, 2014, at 3:25 PM, TMFRoyal wrote:

    Tony--

    It depends on the broker, as each has their own system and nomenclature for the warrants. But often there's a specific tab for warrants. Unlike options, however, each warrant entitles you to purchase just one share of the underlying stock.

    Stop by my discussion board for any other questions. I'm always on there to answer questions.

    Best,

    Jim

  • Report this Comment On August 26, 2014, at 4:00 PM, nontechie wrote:

    At my broker, Fidelity, you can buy the warrants just like stock. The only trick is knowing the trading symbol which, in the case of the "A" warrants is BACWSA.

  • Report this Comment On August 26, 2014, at 4:16 PM, TMFRoyal wrote:

    Yep, the nomenclature changes from house to house. So one has to investigate that first.

    Jim

  • Report this Comment On August 26, 2014, at 6:53 PM, Jclyak wrote:

    Jim, nice write-up. I have a bunch of the warrants, along with jpm and wfc warrants. I've read that the strike price reduction from dividends above $.01 is only half the goodies. Additionally, the excess dividends increase the share count for which each warrant is exerciseable. (Bruce Berkowitz has touted this feature, among others).

    There is a complicated formula, but it appears the extra share feature may be worth more than the strike price reduction, depending on a number of factors, the largest of which is present price at dividend and the final price of the stock at expiration.

    Thoughts?

  • Report this Comment On August 28, 2014, at 2:34 PM, TMFRoyal wrote:

    Hey, Jclyak,

    I replied yesterday, but for some reason it's not showing up.

    See pS-28 here:

    http://www.sec.gov/Archives/edgar/data/70858/000119312510044...

    Jim

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