Strong Insider Action Signals Growth and Caution
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Insider trading is a very helping signal of the future prospects of a stock. As researchers in this paper show, over longer time periods a portfolio based on insider trading can generate abnormal returns. Their portfolio based on insider purchases generated abnormal returns of 6% per year. Insiders have a special view of the inner workings of their firms. In addition, top executives are in charge of capital expenditure programs and are thus intimately aware of the future growth prospects for the firm. Insider actions should not be taken as a silver bullet as the financial crash of 2008 showed that there can be many insiders in an industry who do not truly understand their businesses. Nevertheless, over the long run insider trading can be a great way to add a little alpha.
Mercer International (NASDAQ: MERC) has seen significant volatility in its stock price over the past year. Recently Joel Greenblatt of Gotham Capital and Micheal Price of MFP Investors have added to their position. The earnings of this firm have been not been stable as their EPS was $-2.29 in 2009, $2.89 in 2010, $1.46 in 2011, and $.07 in the first 2 quarters of 2012. The firm operates in the volatile pulp paper business and is an interesting cyclical play. As this article notes the firm has high leverage relative to its industry peers, but apart from a major double dip recession the firm should be able to maintain its profitability. The positive gross margin of 19.20% and an EBIT margin of 7.20% are very encouraging.
Over the past year insider trading in Cracker Barrel Old Country Store (NASDAQ: CBRL) has been mixed. Recently Joel Greenblatt of Gotham Capital and Meridian Funds have sold shares. There is good reason for their selling as the recent rise in the share price comes about in midst of 5 year revenue growth of 1.56% and 5 year EPS growth of .35%. The 3 year growth figures are much higher, but as others have pointed out their performance is only average within the industry. The total debt to equity ratio of 1.37 is not outrageous. Constrained consumers find high quality alternative sit down restaurants in places like Panera Bread and Chipotle and this continues to pose challenges for Cracker Barrel. This stock has a 4 star caps rating but recent insider actions give cause for concern.
Janus Capital Group (NYSE: JNS) has seen a number of strong insider purchases recently from John Rogers of Ariel Capital and Micheal Price of MFP Investors. The 5 year dividend growth rate of 42.12% is an obvious positive quality for investors but the -4.03% decrease in revenue growth over the same time period points to deeper issues. With the advent of cheap ETF funds and the general investor dislike for equities given the 2008 recession there are deep issues with this mutual fund company. In the recent earnings transcript the company stated that they are starting to diversify their offers to be less dependent on equities. The price to earnings ratio of 15 is reasonable considering the long term average price to earnings ratio of the whole stock market. Given the advent of cheap ETFs with substantially lower expense ratios than those offered by mutual funds there is certainly some degree of risk in this firm. Regardless of these factors Janus is profitable and although ETFs have removed some of the glory of mutual funds the reality is there has and will be demand for actively managed funds. The current price to earnings ratio is not spectacular but it is not extremely over priced either.
Over the past year Constellation Brands (NYSE: STZ) has seen a number of insiders selling in the midst of the increase in their share price. This is a very negative sign when taken in conjunction with the fact that revenue has shrunk by -7.89% over the past 5 years and -20.30% over the past year. The firm's profit margin of 15.2% is only average relative to their peers as others have noted. The price to earnings ratio of 17.2 is higher than the long term average of 15. Given the recent insider selling, only average performance relative to peers, and negative revenue growth over the past 5 years this company does not appear to be a great investment at the moment.
Following the actions of insiders is a great way to improve one's portfolio. Although insiders are not right all of the time they have better access to information and more powerful analysts than the average investor. Mercer and Janus are some of the few stocks with recent insider purchases which appear ripe for growth. Constellation and Cracker Barrel have a number of negative factors and only average performance relative to their peers which makes them more risky investments.
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