Peek "Inside" Chesapeake

07/08/2005 12:00 am EST

Focus:

Alexander Green

Chief Investment Strategist, The Oxford Club

Among the factors considered by value investor Alexander Green is insider buying. Such buying led to his recommendation for Chesapeake Energy. And with insiders continuing to buy at the stock's highs, he continues to recommend purchase. Here's the "inside" scoop.

"When Chesapeake Energy (CHK NYSE) announced first-quarter earnings last month of $125 million, on a 39% jump in revenues, few of our Oxford Club members were surprised. This is one success story that's been about as well concealed as Shaquille O'Neal ambling through a KinderCare. For those just starting to follow this situation, let's start with the fundamentals. Chesapeake is one of the five largest independent natural gas producers in the US, with interests in over 14,000 onshore domestic wells. The company has enormous properties in Oklahoma, Arkansas, Texas, Kansas, Louisiana, New Mexico, North Dakota, and Montana, and owns the rights to more than three trillion cubic feet of natural gas. Further, the company is rapidly exploring new sites. Chesapeake, in fact, is the #1 driller in the US. And it is growing through acquisitions, as well.

"However, none of these factors were our primary reason for recommending the stock. (Nor was it due to rising natural gas prices. Although that hasn't hurt.) No, our main reason was because for the last two years president Tom Ward and chairman Aubrey McClendon have been gobbling up shares like pigs at the trough. Ward now owns more than 13.5 million shares. McClendon owns more than 15.2 million shares. (That's what I call eating your own cooking.) To say this heavy insider buying has been a positive signal is a bit of an understatement. Our shares of Chesapeake have more than doubled since we got in 19 months ago, returning nearly seven times as much as the S&P 500 over the same period.

"Of course, some investors will say it's too late to buy Chesapeake now. But I know two individuals who will be happy to play devil's advocate: Ward and McClendon. On June 2, Ward bought 100,000 more shares of Chesapeake at a cost of more than $2 million. From June 2 to 6, McClendon bought 200,000 shares, an investment of more than $4 million. McClendon then bought another 100,000 shares, for more than $2 million. And he then bought another 50,000 shares, for $1.11 million.

"Ordinarily, insiders buy at the low end of a stock's range. And this is often a positive sign. But when they diverge from the norm, and buy as the stock is hitting new highs, it can be an even more powerful signal. The reasoning is straightforward. When a stock reaches a new altitude, it shows the market realizes the company's business prospects are exceptional. But when insiders are still clamoring to buy as the stock is hitting these highs, it means the market still doesn't realize just how good things are. In other words, Chesapeake Energy is still worth buying."

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