An Insider Bought 28,000 Shares of This Internet Company

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According to a Form 4 filed with the SEC, Fredric Reynolds, a member of the board of directors at AOL (NYSE: AOL), purchased 28,000 shares of the stock on May 29 at an average price of $34.26 per share. Insider purchases should reflect confidence in the company; otherwise, according to economic theory, company insiders should prefer to diversify their wealth. Studies tend to show a small out-performance effect for stocks bought by insiders (read our analysis of studies on insider trading). As a result we think that it’s a good idea to review recent insider purchases to see if the stock or its peers might be good targets for further research.

AOL acts as a web portal, including through its subscription business, and also owns a portfolio of electronic media brands, including the Huffington Post. In the first quarter of 2013, revenue was up slightly versus a year earlier as declines in subscription revenue were offset by advertising sales. With selling, general and administrative (SGA) expenses significantly reduced, AOL experienced a 23% increase in earnings, and with the company’s share count also falling earnings per share came in at $0.32 (up from $0.22 a year ago).

Cash flow from operations also increased significantly, and AOL reported about $470 million in cash on its balance sheet in comparison to about $130 million in long-term liabilities. The stock is actually somewhat expensive in terms of earnings- analyst expectations for 2014 imply a forward P/E of 19, though when we take into account the company’s cash haul the valuation metrics look significantly better with a trailing EV/EBITDA multiple of 4.8x.

We track quarterly 13F filings from hundreds of hedge funds and other notable investors, using the included information to help us develop investing strategies (we have found, for example, that the most popular small-cap stocks among hedge funds earn an average excess return of 18 percentage points per year). We can also use our database to see which individual managers like AOL. Billionaire David Shaw’s D.E. Shaw cut its stake in the company by 27% during Q1, but still owned 2.3 million shares (see D.E. Shaw's stock picks).

Competitive landscape

AOL’s peers include Yahoo! (NASDAQ: YHOO) and IAC/InterActiveCorp. IAC has been experiencing a higher level of both revenue and earnings, and while to some degree that company’s valuation already captures some future growth opportunities, analysts consider the stock undervalued. Specifically, IAC trades at 10 times consensus earnings forecasts for 2014 and at a five-year PEG ratio well below 1. We’d be interested in learning more about the company.

Yahoo! has been quite acquisitive lately, buying Tumblr and reportedly bidding for Hulu, and we’d certainly be concerned about integration risk there. With the stock price rising 75% in the last year as new CEO Marissa Mayer has also been shedding assets (and the company’ Japanese assets have risen in value), Yahoo!’s forward P/E is 17.

We can also compare AOL to Google and Microsoft (NASDAQ: MSFT), as MSN Online and Google’s various offerings serve as competing web portals. Google actually trades at a small premium to AOL and Yahoo! on a forward earnings basis with a P/E of 16 (though the sell-side is assuming high earnings growth over the next year and a half). Last quarter net income grew 16% compared to the first quarter of 2012, though it still may be worth waiting for another quarter or two of results.

While Microsoft is valued at 12 times forward earnings estimates, we’d be somewhat concerned that earnings will be temporarily high in that fiscal year due to the release of new versions of Windows and Office. We’d note that the stock has popped over 20% during Q2.

Bottom line

The insider purchase at AOL is certainly large enough to be notable, but next year’s expected earnings leave the stock at a premium valuation compared to its peers. While AOL does certainly have a good deal of cash on hand, the same is true for many other technology companies. We certainly think that investors should take a closer look at IAC/Interactive, and it may be worth watching for future developments at the rest of the companies we’ve mentioned here as well.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has long positions in Google and Microsoft.The Motley Fool recommends Google. The Motley Fool owns shares of Google and Microsoft. 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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