An Insider Is Bullish About This Spinout Stock

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ADT (NYSE: ADT) was spun out from Tyco International (NYSE: TYC) in September 2012 as a pure-play home and business security business. As a spinout, this event received significant attention from many investors; these companies often make good investments because management of the new company can better focus on operations without having to satisfy the needs of the larger business (read more about spinouts).

Now a member of ADT’s Board of Directors, Thomas Colligan, has purchased 2,000 shares of the stock at an average price of about $47.35 according to a recent filing with the SEC. This gives Colligan almost 4,000 shares of ADT, so this transaction has more than doubled his direct holdings. In addition to the positive nature of a spinout, we also like to see insiders buying a stock, as it signals enough confidence in the company to ignore the benefits of diversification. We think that this is why insider purchases tend to be bullish signals on average (read more about studies on insider trading).

ADT recently filed its quarterly report for the quarter ending December 2012, the first of its current fiscal year. Clearly comparisons to a year ago should be taken with a grain of salt due to ADT’s presence within Tyco at that time, but it’s necessary to get at least some information about how the business is performing. The report showed a small amount of revenue growth versus a year earlier but a 13% increase in earnings due to higher margins (even accounting for some separation costs and an increase in SGA expenses). The 44 cents per share that ADT produced in the quarter annualizes to $1.76, or a price-to-earnings multiple of 27. This straight annualization assumes little seasonality, but also does not give ADT any credit for eliminating its separation costs or improving core operations as an independent business.

Wall Street analyst estimates for the forward fiscal year, ending in September 2014, imply a forward P/E of 24. That is a fairly high multiple, and so it appears that the market is being more optimistic about ADT’s prospects than the sell-side. In order to prove fairly valued at the current price--let alone undervalued enough to buy--either analyst consensus is dramatically underestimating the improvements that will be made at the company, or ADT will be able to generate higher earnings growth a couple years from now than it has been reporting. We’d be wary about depending on either factor. Read another analysis of ADT.

Peers for ADT include Brinks (NYSE: BCO), Ascent Capital Group (NASDAQ: ASCMA), and Checkpoint Systems (NYSE: CKP). Checkpoint and Ascent Capital are expected to be unprofitable for 2012, and Ascent is expected to report negative earnings this year as well. With that company experiencing only moderate growth we would avoid it. Checkpoint is expected to recover, with analyst consensus for 2013 implying a current-year P/E of 16, but its most recent quarterly report showed a decline in sales, and while net losses were only narrowly negative, they did miss expectations substantially. Brink’s bottom line performance has been strong, though revenue growth has been much more limited, so we doubt that earnings growth can be sustained. However, it has at least some value prospects at a trailing P/E of 15 and might be the best deal in the industry.

We like spinouts, particularly ones where an insider has been showing confidence in the new company by buying the stock. However, in the case of ADT the pricing appears high and we might conclude that the market has already spotted the opportunity (the ADT spinout has been high profile) and reacted accordingly. The earnings multiples, even those based on what are normally sunny analyst expectations, are too high for us to recommend buying at this point.

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 has no position in any of the stocks mentioned. 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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