Why is This Company’s CEO Selling More Shares?

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Insider trading activity is often a misused and misunderstood market indicator. To many, the phrase conjures up images of infamous figures like Raj Rajaratnam or Martha Stewart, where cases of corporate greed and illegality were prosecuted by the SEC. In reality however, the overwhelming majority of all insider trades are 100% legal, and are reported to the federal government via Form 4 filings.

Despite their atrocious reputation, the transactions performed by insiders can help individual investors profit quite handsomely. In fact, empirical studies have proven that individuals who mimic or “monkey,” insider trading activity can beat the market by an average of 7 percentage points a year. This strategy is no flash in the pan, as a statistically significant correlation between insider transactions and excess returns has been observed for the past half-century.

In recent weeks, we’ve seen a bevy of insider buying activity, though it’s also important to take a quick look at the bears’ sentiment as well. While insider selling isn’t as strong an indicator as purchases are, it is still something that investors should take seriously, as it’s foolish to assume that every insider sale is pure profit-taking. Some rounds of insider selling activity may be a sign that a particular company faces a difficult road ahead, whether it’s in the form of an earnings miss, an unwanted takeover, or a market overvaluation. Without further ado, here’s one stock that has seen insider selling as of late.

Sirius XM Radio Inc (NASDAQ: SIRI) has been in the news quite a bit recently, as Liberty Media Corp (NASDAQ: STRZA) vies for a majority stake in the multi-billion broadcasting company. All of this drama began in 2009, when Liberty Media bailed Sirius out of bankruptcy with a $530 million loan that gave it a 40% stake in the company. Three years later, a clause preventing Liberty from purchasing additional shares has expired, and its stake currently lies less than one percentage point away from the 50% threshold. While Sirius’s shareholders are determined to do anything in their power to prevent a takeover, whether through the form of “poison pill” or “macaroni” defenses, an agreement in the company’s bailout plan outlaws any anti-acquisitive measures.

Interestingly, one very prominent Sirius insider has been selling their shares as of late, and it’s worth delving a bit into the details. On the 17th, 18th, and 19th of this month, the company’s CEO Mel Karmazin sold a total of 20.36 million shares in stock worth a total of nearly $50 million. Karmazin’s Form 4 filings reveal that the majority of these sales were performed via stock options in the 50 cent range, allowing the executive to bank an instant return of 420 percentage points when he sold at them at the going market rate between $2.37-$2.57 a share.

These most recent transactions are part of a larger bearish trend for Karmazin, as he sold 15.95 million shares in August, and 7.8 million in July. Sirius’s head honcho has recently said that his “instincts [...] are Liberty does not need [him] at the company” once a likely takeover is complete. Even more intriguing is that the CEO stated that even he wasn’t aware of Liberty’s plans for Sirius once they acquire a majority stake, telling reporters that “we really don’t know what exactly their interest is … they are not talking to us.”

To put it simply, Karmazin’s sentiment toward Sirius XM combined with Liberty’s takeover efforts creates a massive amount of uncertainty for investors at the moment. Since the start of September, Sirius’s shares appear to be in a relatively stable holding pattern, generating a slight amount of positive appreciation over this time. They currently trade at parity with the radio broadcasting industry with respect to their earnings valuation (4.8X), and are actually below traditional peers like Corus Entertainment Inc. (CJREF) at 15.2X, and Cumulus Media Inc. (NASDAQ: CMLS) at 18.2X.

Sirius still sports a whopping PEG ratio of 4.89, despite expecting annual earnings growth of 25% a year over the next half-decade. Typically, a PEG above 2.0 signals an overvaluation. From a forward-looking perspective, shares of Sirius trade at a moderate Forward P/E of 25.9X, which is above both Cumulus and Corus, but one-twentieth the price of online competitor Pandora Media Inc (NYSE: P). Specifically, Cumulus trades at a Forward P/E of 11.5X, while Pandora trades at Forward P/E of 131.6X. Of the companies mentioned here, only Pandora has a higher EPS outlook, expecting to average 39.5% bottom line expansion over the next five years. Like Sirius though, Pandora has a PEG ratio in excess of 4.00.

Sirius in sitting on free cash in excess of $500 million, having grown its cash hoard by a whopping 177% post-recession. Interestingly, this growth is above Pandora (93%), but below Cumulus (280%), though we can see that investors are overvaluing Sirius’s growth by looking at cash flow multiples. Cumulus trades at a measly P/CF of 3.9X, while Sirius’s is much higher, at 26.7X. Pandora, meanwhile, trades at a P/CF of 21.6X. In comparison to their five-year historical averages, Sirius trades at a much larger premium (70.1%) than both Cumulus (18.2%) and Pandora (-95.2%).

To conclude: Sirius does not look exceptionally attractive from a valuation standpoint whether we use earnings or cash flow multiples, and there is too much uncertainty regarding the takeover efforts of Liberty Media. Though most of Mel Karmazin’s stock sales look like profit-taking, investors can’t help but wonder if they’d be better off mimicking this insider.

While it’s always important to track insider trading activity, it shouldn’t form an investors entire stock trading strategy. In most cases, this kind of information can serve as a first stage of analysis, that prompts a further look at stocks with heavy bearish or bullish insider sentiment. For a continued look at this useful market indicator, check out Insider Monkey’s insider trading database.

This article is written by Jake Mann and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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