Don’t Copy the Insider Purchase at This Company

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A filing with the SEC has disclosed that John Cavoores and his wife jointly purchased 1,000 shares of Guidewire Software (NYSE: GWRE) on Jan. 9 at an average price of $31.06 per share; Cavoores serves on the company’s Board of Directors and so this transaction had to be reported as an insider purchase. He now has voting power over a little more than 4,000 shares, about half of which are held jointly with his wife. Guidewire is a software and services company primarily selling to property and casualty insurance companies in the U.S., Canada, and Australia. It went public in January 2012 and is currently up 81% from its levels shortly after the IPO.

We track insider purchases because, logically, they should only take place when an insider is particularly confident in the company; the insider already has an economic connection to the company and the principles of diversification say that one should avoid being even further exposed to events that might affect that company. This is why stocks bought by insiders outperform the market under some conditions (read more about studies on insider trading). However, we’d be cautious in this particular case as there has been heavy insider selling at Guidewire Software in the last month (research insider sales at Guidewire). Sales by insiders generally aren’t meaningful since diversification makes selling rational, but the volume of transactions in that direction is worth noting.

The first quarter of Guidewire’s fiscal year ended in October. The company reported a 40% increase in revenue, with the services segment being the largest contributor to growth. However, gross profits were up at a much lower rate and significant operating expenses resulted in negative operating income for the quarter. Non-operating factors did result in positive net income but overall the results were quite poor. This is particularly troubling as the stock is priced for high growth: The forward P/E, based on consensus earnings for the fiscal year ending in June 2014, is 78.

For a $1.8 billion market cap stock, Guidewire Software has very little following in the hedge fund community: The largest position in our database of 13f filings from funds and other notable investors was less than $10 million. Citadel Investment Group, managed by billionaire Ken Griffin, owned about 320,000 shares at the end of the third quarter, and this was a very small percentage of that fund’s invested assets (in addition to being down 30% from three months earlier). Driehaus Capital and White Elm Capital were two funds buying the stock.

As a business application software company, we can compare Guidewire to Verint Systems (NASDAQ: VRNT), Sapient Corporation (NASDAQ: SAPE), Qlik Technologies (NASDAQ: QLIK), and SS and C Technologies Holdings (NASDAQ: SSNC). When we look at these peers, we generally see forward P/Es of less than 20, and less than 15 in the cases of Verint and SS&C. Qlik is the exception, with high earnings multiples despite an 88% decline in earnings in the third quarter of 2012 versus a year earlier. We think that it joins Guidewire as a poor buy. The other three companies experienced at least some revenue growth, though Verint’s net income was down considerably. We would note that even in these cases the low forward multiples are based on expected growth; none of them look like a good value in terms of their trailing earnings, with the lowest P/E on that basis belonging to Sapient at 22. As a result we’re skeptical that any of these stocks offer an attractive combination of being cheap and performing well.

We don’t think that this is a good insider purchase for investors to follow, as Guidewire--and the other stocks in its industry--actually seem to be overvalued. Even the companies with decent financial performance are priced at high earnings multiples and don’t look like good value prospects. In Guidewire’s case there has been significant insider selling as well.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Qlik Technologies. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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