Tag Archives: stock

The Recent Insider Selling Tells You Zip. Insider Buying Says Much More

In the ongoing debate about whether stocks are cheap or too expensive, the bears got some assurance from news that insider selling is on the rise. Investors often watch what insiders do because insiders are supposed to be better informed about their companies than the rest of us. So if insiders are selling, it must be because they know stocks are overvalued. Right? Not necessarily. I’m in the camp that believes stocks in general are too expensive right now. I would not be surprised to see another round of insider selling in the near future. Yet insider selling activity has no bearing on my view. On the contrary, I believe insider selling tells us very little about overvaluation. That’s because there are so many reasons why insiders might sell stock. A conviction that the stock is overvalued is only one possibility. Insiders might sell stock simply to raise cash. After all, insiders sometimes receive a relatively large proportion of their total compensation in the form of stock or options. Actual cash might make up a smaller proportion. So if these insiders want to buy a new home or send their kids to college, they might sell stock to raise cash. Insiders might also sell stock to diversify. It’s simply too risky for anyone to have all of their labor and most of their wealth tied up in just one company. It makes perfect sense for insiders to sell stock every once in a while to spread their wealth into other assets. Here’s yet one more reason why insiders might sell. Many employees are compensated at least in part with stock options. As a result, they can get hit with a tax liability when they exercise their options. They might sell some of the stock they received from exercising the options just to pay Uncle Sam. That’s not to say that a sudden spike in the amount of insider selling couldn’t be something to worry about. However, knowing that there are so many reasons why insiders might sell, I have to conclude that insider selling activity is not a useful signal of a market top. Insider buying is another story entirely. There are many reasons why insiders might sell, but there is only one major reason why insiders would buy. They buy because they believe the stock is undervalued. It’s true that a new member of the board of directors might be encouraged to buy some stock just for appearance’s sake, but that’s an exception to the rule. If insiders are using their own cash to buy stock, that a bullish signal. This just happened at one of the companies on my Bottom Line’s Money Masters recommended stock list. This company recently announced quarterly earnings that fell short of expectations. As often happens in such cases, the stock sold off in response. Yet my analysis convinced me that this stock is extremely undervalued. Apparently, several insiders agree. At least five of them purchased shares following the selloff. The CEO bought the most, spending $185,000 of his own money. That might not seem like a lot, but he didn’t acquire the stock as a result of an employee ownership plan or the exercise of options. He made a direct purchase on the open market using real cash. This CEO already owned a large stake in the company. The fact that he is willing to add to that stake should send a clear signal to other shareholders that the guy running the company is convinced the stock is cheap – so convinced that he is putting his money where his mouth is.

Buying Stocks Trading Below Net Current Asset Value Vs. Market Timing

Given the fees derived from selling funds to the retail public, financial institutions have little incentive to be bearish on the stock market. These financial behemoths want euphoric investors believing that Wall Street is Lake Wobegon , where every day is a sunny day and all of the stocks are above average. Following the investment strategy of remaining fully invested in stocks and not attempting to time the market does have merit. An academic paper written by Nobel Laureate William F. Sharpe showed the difficulty associated with market timing [i] . Over the study period of 1934-1972, investors who made the decision at the start of every calendar year to be in either cash or stocks had to bet correctly 83% of the time in order to outperform the Standard & Poor’s 500 Index (S&P 500®). That is a difficult hurdle to overcome. Given these poor odds of timing the market with such precision, betting black on the roulette table at a casino in Vegas looks attractive by comparison, with free drinks to boot. Should investors heed the warning of Dr. Sharpe by buying a stock index fund and abandoning any attempt at market timing? Let us take a step back for a moment before going “all in” on stocks. Is there a third way to outperform a broad market average other than choosing cash or an index fund with near-perfect timing accuracy? An alternate investment path to consider is Benjamin Graham’s value investing philosophy for the enterprising investor. Graham showed superior portfolio performance by selecting securities trading below net current asset value (NCAV). The NCAV calculation subtracts all liabilities , including preferred stock, from the current assets (the most liquid assets) on a company’s balance sheet. The NCAV calculation is converted to a per share figure, comparing the value to the company’s share price. If Mr. Market quotes the stock price below the NCAV calculation, it can be considered a buy. The chart below shows the long-term performance of restricting stock purchases to ones trading below NCAV and comparing the results to that of the S&P 500®. (click to enlarge) * Portfolio average return calculations include only stocks trading below 75% of NCAV, with no more than a 5% weighting in any one stock. Dividends and transaction fees are included in all of the calculations. As indicated on the chart, NCAV stocks outperform the index by around six percent on an average annual basis. These stellar results do not require an investor to be permanently in stocks all of the time or to engage in market timing. In approximately three of four years, part of the NCAV portfolio remained on the sidelines sitting in a money market fund. Unlike remaining fully invested in the S&P 500®, investors who restrict their stock purchases to ones trading below NCAV will at times have a portion of capital remaining in cash. These idle time periods out of the stock market due to the lack of NCAV investment opportunities occur in both advancing and declining calendar years. If the stock market moves higher for the calendar year and few stocks trade below NCAV, the portfolio will lag a fully invested index fund. If the stock market has a good year, sitting in cash turns out to be a mistake. As indicated in the chart above, temporary time periods where the NCAV remains idle in cash does not result in long-term underperformance in comparison with the S&P 500® broad market average. Embracing this form of deep value investing has the added benefit of being agnostic regarding the direction of the overall stock market. Market timing is not an issue when it comes to purchasing only stocks trading below NCAV. Investors can ignore what prognosticators on Wall Street think stocks are going to do in the future. The efficient market hypothesis implies that greater portfolio volatility must be accepted in order to achieve a greater average rate of return. There is truth to this argument. Markets are generally efficient, and the NCAV portfolio does fluctuate more than the S&P 500® does. If our measure of risk changes from portfolio volatility to worst-case return, a wrinkle in the market efficiency gospel bubbles up to the surface. We know from behavioral finance research that losses are far more painful to investors than is the satisfaction derived from an equivalent-sized gain. Using a worst-case annual return as our alternate measure of portfolio risk makes sense if money lost is more important to investors than money won in the stock market. As shown in the table below, using the worst annual stock market loss as our measure of portfolio risk, the NCAV portfolio does not suffer through as bad of a drawdown. For many years over our study period, the NCAV portfolio was not fully invested in stocks. When a portion of capital remains on the sidelines for the NCAV portfolio, it makes sense that a worst-case calendar year loss is less severe in comparison with a fully invested stock index fund, such as the S&P 500®. As already shown, this more limited exposure to stocks by investing only in securities trading below NCAV does not result in the average compounded return falling below the S&P 500® over the long term. (click to enlarge) Market timing is an exercise in futility for individual investors. As I pointed out in a previous blog , focusing on individual stock selection using a time-tested value-investing criterion, such as NCAV, is a far more productive use of an investor’s time rather than attempting to figure out the future direction of the overall stock market. Stocks trading at a deep discount to NCAV not only outperform the market over the long term but also benefit from limited downside losses when knee deep in a bad year for stocks. Although not shown in the chart, the second and third worst annual returns of the S&P 500® had a deeper drawdown than the index’s matching year NCAV portfolio return did. A patient investor willing to endure temporary time periods when deep value investing falls out of favor can still do well over the long term. This holds true without the additional requirement of prescient forecasting on the future direction of stocks. [i] Financial Analysts Journal. “Likely Gains from Market Timing” by William F. Sharpe – March/April 1975, Volume 31 Issue 2 pp. 60-69.

Buy Dominion Resources For A Nice Dividend And High Analyst Price Targets

Merrill Lynch has a price target 17% above current price of $67.9. Analysts are getting generally more positive on utilities after a year of relative underperformance. The company is one of the safest investments in the market right now. In his now legendary book, The Intelligent Investor, Benjamin Graham writes that the goal of a conservative investor is to look for investments that are likely to provide safety of principle and an adequate return. His disciple, Warren Buffett has put it slightly differently saying, “The first rule of investing is don’t lose money. The second rule is don’t forget the first rule.” Utility companies in general are a good place to look for this type of conservative investment, and it doesn’t get any safer than Dominion Resources, Inc. (NYSE: D ). D is one of the nation’s largest utilities with a market cap of over $40 billion and rock solid fundamentals. In addition to the company’s great fundamentals is the fact that analysts are lining up with price targets higher than the current price across the board. Merrill Lynch recently set a price target of $80 a share. While this is one of the higher targets, the mean target among a relatively large sample of 17 brokers isn’t far off at $78. Both of these figures provide generous upside to the stock, especially for a utility company that usually trades within a tight range. Research firm Guggenhiem also rates the stock a “buy”. D recently posted quarterly YoY earnings growth of 12% with a profit margin of almost 15%. This is a much higher margin than the industry average of 8-10%. With a forward P/E of 17, the company looks fairly valued. While 17 is slightly higher than average for a utilities company, in this case the higher multiple reflects the high quality of the company. As mentioned above, there aren’t very many utility companies that have 12% margins are growing the bottom line by 15%. This helps to make the 3.7% dividend sustainable. The company’s ROE of 14.54% is also quite strong for a utilities company, so it appears as if D is outperforming the industry pretty much across the board. As if all of the above weren’t enough to convince the conservative investor in the value of D as a safe long term bet, the stock has been picked as a top dividend stock by the Dividend Channel’s “DividendRank” report . The lowest the stock has traded in the last 52 weeks is $64 a share, which is only $4 below the current price, which is a technical indicator that points to short term upside. So by almost any measurement the stock is either fairly valued or undervalued. I rank the stock a strong “buy” for the investor looking for long term safety of principle and an adequate return. And of course we can collect the nice dividend while we wait.