Warren Buffett is the primary shareholder, chairman and chief executive officer of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), and he's deemed the "Oracle of Omaha" for his intuitive value investing prowess. Being one of the world's 1,210 billionaires, and arguably the best and most well-known investor of all time has its privileges. As far as investing goes, Buffett's big bucks give him access to preferred stock, high-paying dividends and warrants when purchasing equities. (For more on Warren Buffett, check out Warren Buffett: How He Does It.)
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Corporations issue preferred stocks to raise cash. Preferred stock shares are technically equity securities but they share some of the same characteristics as debt instruments, such as bonds. Preferred shares pay fixed dividends typically for the life of the stock, and the dividends on preferred shares are paid before the company pays out dividends to common shareholders. Preferred stocks, like bonds, are given a rating by the major credit rating companies such as Moody's or Standard & Poor's.
Many companies offer dividends to their stockholders. Dividends are essentially a distribution of a portion of the company's profits paid to stockholders on a quarterly, semi-annual or annual basis. The dividend a company pays on preferred shares is fixed, but it exceeds the dividend that is paid on its common stock.
A warrant is a type of derivative security that is similar to an options contract. Warrants give the holder the right but not the obligation to purchase a certain number of shares at a specified price (called the strike price) on or before a certain date (called the expiration date). Unlike options, which trade on a stock exchange, warrants are issued by the company. Warrants can generate large profits when stock prices rise above the warrant's strike price.
Buffett's Supersized Deals
The old saying is true: It takes money to make money. Since Buffett has incredible buying power, his deals tend to be, well, supersized. Billions of dollars worth of preferred shares often bring hefty dividends and the warrants issued by companies only sweeten the deal. Most recently, Buffett pumped $5 billion into Bank of America (Buffett said the idea came to him while he was in the bathtub and the deal took place within 24 hours).
Bank of America
In late August 2011, Buffett invested $5 billion into a struggling Bank of America (NYSE:BAC). According to news reports, Buffett will earn a 6% annual dividend for 50,000 shares of the preferred stock, which Bank of America can buy back at any time by paying Buffett a 5% premium. (By comparison, Bank of America's common stock dividend has been 1 cent since January of 2009).
In addition, Berkshire Hathaway will receive warrants to buy 700 million shares of Bank of America's common stock within 10 years of the transaction's closing date - at an exercise price of approximately $7.14 per share. That stands to be a lucrative deal; if Bank of America shares, which are now trading in the $7 range, rise to just half of their pre-economic crisis high of $55.08, Buffett and Berkshire Hathaway would be looking at nearly $14 billion in profits.
Goldman Sachs Group
In September 2008, Warren Buffett agreed to invest $5 billion in Goldman Sachs Group (NYSE:GS) through the purchase of preferred stock on which Buffett will earn a robust 10% dividend yield, or $500 million per year. Buffett also received as part of the deal immediately exercisable warrants to purchase 43.5 million common shares with a strike price of $115 per share. Though Goldman shares had been trading close to $250 a share during the previous year, prices tanked (with the rest of the stock market) until bouncing of an October 2009 low of $53.51. Goldman received regulators' permission in March, 2011 to repurchase the preferred shares for $5.65 billion, a move Goldman was eager to make in light of the half-billion dollar yearly dividend payout. (Buffett had said happily that this dividend earned him $16 a second). Buffett has until the fall of 2013 to exercise the warrants; Goldman shares are currently trading in a 52-week range of $99.78 - $175.34.
The Bottom Line
Warren Buffett definitely has certain advantages that the rest of us don't have when purchasing equities: buying power and reputation. Most investors would love to earn a 10% dividend, even on a small investment. Take that 10% and attach it to $5 billion worth of preferred stock and it really earns money – like $16 per second (or $57,600 every hour). The special deals that Buffett receives usually benefit his bottom line, but the companies know his involvement can also have a lasting and positive effect on their success as well. (For more on Warren Buffett, check out Warren Buffett: The Road To Riches.)