ADT: Time to Catch the Falling Knife?

03/07/2014 7:00 am EST

Focus: STOCKS

John Dobosz

Editor, Forbes Premium Income Report and Forbes Dividend Investor

There's an old maxim on Wall Street that says you shouldn't try to catch a falling knife; like a knife, your attempt to catch a stock in freefall may result in some significant damage, explains John Dobosz, editor of Forbes Dividend Investor.

With that cautionary prologue, let's get to our rationale for buying The ADT Corporation (ADT) now—after reporting quarterly results that fell short of expectations.

On January 30, the Boca Raton, Florida-based electronic security service for homes and businesses reported earnings for the October to December period of $0.43 per share on revenue of $839 million, falling well short of analysts' consensus for $0.49 in EPS and revenue of $850.7 million.

Over the next three days, the stock fell from $37.81 to $28.83 per share. That's when ADT insiders started buying the stock aggressively. On February 3, two directors purchased $181,000 worth of ADT shares, around $30.25 each.

On the same day, even more significantly, ADT's chief financial officer, Michael Geltzeiler, purchased $295,900 worth of ADT at $29.59. Five additional company officers spent another $221,000 collectively on ADT stock between February 3 and yesterday.

With the stock up about $3 from its lows, those buys have proven to be smart ones and have made a good case to try to get a handle on this falling knife.

Dividends are another good reason to get into ADT, which has paid them quarterly since its spinoff from Tyco in October 2012. ADT jacked up the quarterly payout by 60% from $0.125 to $0.20 per share in the most recent quarter.

Even at the higher rate, the dividend is just 42% of expected earnings, and only 9.2% of the $8.67 per share in cash from operations over the past 12 months.

Although it has a limited history as a stand-alone company, ADT looks cheap. Since its IPO, the stock has traded for an average of 2.68 times sales, a multiple that's 43% higher than its present price-sales ratio of 1.87.

ADT's average price-earnings ratio is 21.8 times earnings, a multiple that corresponds to a $41.85 stock price, using 2014 expected EPS of $1.92.

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