Insiders Are Crazy About This Financial Stock

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Recent filings with the SEC show that two members of Capital One Financial's (NYSE: COF) board of directors each bought about 2,000 shares of the stock on April 26 at prices of about $57 per share. We track insider purchases because studies show that buying by insiders is at least something of a bullish signal. When multiple insiders are buying, the average effect becomes stronger (read our analysis of studies on consensus insider purchases).

We think that this correlation occurs because insiders have an economic incentive to diversify their wealth rather than add more company-specific risk, and so insider purchases should tend to take place when insiders are more confident than usual in the company’s prospects. As a result, we consider stocks bought by insiders, particularly by multiple insiders, to be a useful source of initial investment ideas.

In the first quarter of 2013, Capital One’s pretax income increased by 30% compared to the first quarter of 2012 if we correct for the effects of an extraordinary gain in that period (earnings came in lower as a result of both that gain and a higher effective tax rate in Q1 2013). This was fueled by considerably higher net interest income, which offset growth in non-interest expenses.

Capital One also delivered significant growth on a q/q basis. Currently the market is being cautious in terms of valuation, with the stock trading at only 11 times its trailing earnings and at a discount to the book value of its equity with a P/B ratio of 0.8. At those levels Capital One could be a good value just by maintaining its current business, and we’d be interested in learning more about the company.

In addition to insider purchases, we also monitor quarterly 13F filings from hedge funds and other notable investors both to help us develop investing strategies (for example, the most popular small-cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and to see how individual managers are trading individual stocks such as Capital One.

We can see that billionaire Andreas Halvorsen’s Viking Global reported owning almost 14 million shares at the end of December, an increase from what it had owned three months earlier. Lone Pine Capital, managed by billionaire Stephen Mandel, initiated a position of 4.4 million shares.

Good peers

American Express (NYSE: AXP) and Discover Financial Services (NYSE: DFS) are good peers for Capital One, and we can also compare the stock to credit-card brands Visa (NYSE: V) and MasterCard (NYSE: MA).

Discover is also in value territory from our perspective, with its trailing earnings multiple coming in at 10 and with both revenue and earnings increasing in its most recent quarter compared to the same period in the previous fiscal year. As such it looks worthy of further research.

Wall Street analysts expect American Express to improve its bottom line over the next couple years, but given its trailing earnings it does not look undervalued and its last quarterly report shows little change in revenue or earnings versus a year earlier. Visa and MasterCard receive more premium valuations from the market, and as a result their forward P/E's are in the 18 to 20 range. We can certainly see these two companies doing well in the future, but revenue growth of “only” 10% or so (which is about what Visa and MasterCard did in their last quarterly reports from a year ago) is not particularly strong given their pricing.

As a result we think that we would avoid American Express, Visa, and MasterCard, at least for now. Capital One and Discover don’t have as favorable a brand as those three companies, but their stock prices are low relative to the current state of their businesses and recent financial results have been positive. We think that either of the two would be worth considering on a value basis.

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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 American Express, MasterCard, and Visa. The Motley Fool owns shares of MasterCard. 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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