Trading is not a game of exacts. Perfectionists need not apply. Markets are made up of many irration...
Green's Insider Plays
02/11/2005 12:00 am EST
"One of the ways we maximize returns while minimizing risk is by riding the coattails of knowledgeable insiders," says Alexander Green. Here, in a fascinating workshop, he explains the "legal" kind of insider trading and some of his favorite insider plays.
"If you look at all the great investors, they all say they have no clue as to what the market is going to do. All they know how to do is to identify a company that is selling for far less than its intrinsic value and then sell that company when the market recognizes that value. That is the philosophy that we follow. And one of the most successful ways we have found to do that is to analyze what insiders are doing.
"Insider buying is the ultimate leading indicator. I don’t think it’s possible to get a more compelling buy signal in the stock market than when you see a significant number of insiders – the executives who run the company – buying lots of the company stock with their own money at current market prices. I just don’t think it gets much better than that. Clearly, insiders do have an ‘unfair advantage.’ These people have access to material and non-public information that they can hardly forget when they go in the market to trade. When I say material, I mean it’s very relevant to the future prospects of the business. And non-public is information that those of us on the outside looking in couldn’t possibly hope to see. That’s what makes their trading so compelling.
"When I watch what insiders are doing, I score the officers the highest because they know the most. The officers are those who actually run the company and oversee the day-to-day operations. They really know about everything related to the company. Is it legal? Yes. Many years ago, Congress decided that in a capitalist society, you can’t prohibit the people who run a business from taking an ownership stake in it. But they also realized that these people had this 'unfair advantage' when they went in the market to trade. So as a compromise, when these insiders buy or sell, they have to report those transactions to the SEC within 48 hours.
"But you can’t simply look at what a few insiders are doing and just jump on board. You have to analyze the type of insider activity. One of the biggest criteria I have is that I look for the size of the transaction. For me, the bigger the transaction, the more the conviction that the insider has. I want to see people buying hundreds of thousands or millions of dollars worth, and under the best of circumstances, millions of shares. That shows a high degree of confidence that the shares are undervalued. The second thing I look at is the trading history of the insiders. I also look for buying clusters. I really don’t want to see one insider being the lone ranger. If you see a consensus, where you see lots of insiders buying at the same time with their own money, than that is a very powerful signal. And sometimes when you see the small insiders buying along with big insiders, that’s a very positive signal.
"Here are some companies experiencing some heavy insider buying lately. You might want to look into these a little further to see if they fit in your portfolio.
"Chesapeake Energy (CHK NYSE) is one of the biggest independent oil and gas producers in the country. They have more than 10,000 wells. They have over 3 trillion cubic feet of natural gas. We all know what’s happening to energy prices. The company has had very successful exploration efforts. They are on an acquisition binge, which has increased output. And the chairman and the CEO have not just been buying millions of dollars, they have bought millions of shares. They have been buying the stock steadily for over a year. If you want an interesting oil and gas play, this is one.
"Another stock we like is Martek Bioscience (MATK NASDAQ). Martek makes nutritional oils that are supplements to baby formula. There have been all sorts of studies that show that infants that drink this formula end up with everything from better health to higher IQ scores later in life. Its supplements are used in 60% of the global infant formula market. This is a $7.8 billion market. In a lot of third world countries, where infant nutrition is low, there’s a good possibility that governments will start to subsidize the use of this formula in their poorer regions. This could be a real earnings windfall. Already, for the fiscal year just ended, revenues were up 61% and net income tripled. My estimate is that earnings could triple again this year. Here, we recently saw a small insider buy a few thousand shares. But he bought in unison with big directors and officers who were buying sizable amounts of stock. We take this as a positive sign.
"American Financial Group (AFG NYSE) may seem kind of boring. But that is okay, as long as the profits are exciting. The chairman of the company just bought 25,000 shares, an investment of $742,000. This is a plan vanilla insurance company. But 96% of their revenues have been coming from the US, and now they are extending into Canada, Asia, and Europe. Recent earnings have been superb, up 220%. The stock is dirt cheap, selling for five times earnings and at 62% of sales. This is just a very solid, $2.2 billion company and the insiders own 39% of all the outstanding shares.
"Another insider stock I like is William Lyon Homes (WLS NYSE). A great debate is raging over whether real estate is in a bubble. I’m not a real estate expert, but William Lyons is something of an expert because he runs a company that has been very successful at selling homes in California, Arizona, and Nevada. For the most recent nine months, sales totaled $1.1 billion and doubled last year’s earnings. You’d think that with that kind of growth, the stock would be expensive. But it’s very cheap, selling for six times earnings and half of sales. Mr. Lyon just stepped up a few weeks ago to buy 655,000 shares at a cost of $44 million. That’s a high level of conviction.
"Finally, one last stock is Nvidia (NVDA NASDAQ), which makes graphic accelerators that are used in everything from personal computers to Game Boys and cell phones. They are actually pushing the limits of video processing technology. Computer makers say that Nvidia’s software is so advanced, that they can’t even take advantage of all of it yet. A few weeks ago, they got a big contract with Sony for its Playstation. There has been $20 million in insider purchases recently and I expect the company will double its earnings this year, so there’s plenty of upside ahead."
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