Follow the Insiders

 | Feb 02, 2012 | 2:30 PM EST
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Wednesday's column on the battle between insider buying and short selling really got the old synapses firing. Insider buying is one of the strongest confirming factors for cheap stocks that I have ever found. When insiders are buying shares in companies that trade low on an asset- or enterprise-value basis, it's a good sign they think that the underlying value of the company may be realized soon. Rather than try to contemplate Maryland's double-overtime loss last night or try to make sense of the Orioles' offseason signings, I sat down this morning and ran screens for cheap stocks that have seen recent insider buying.

My first scan shows a lot of insider buying in financial names. It is not just banks, as insurance companies and real estate investment trusts are also seeing strong buying by officers and directors. Mortgage REITs have had a tough go of it the past few months, but insiders seem to think a turnaround is close.

Chimera Investment (CIM) saw strong buying in November and December, as members of the board and management were willing to bet that the worst of times for mortgage REITs is in the rearview. Chimera reduced its dividend last month, but the shares still yield more than 14% and the stock trades at a slight discount to tangible book value.

Capstead Mortgage (CMO) has also seen insider buying in its shares in recent months and is currently yielding a little more than 14%.

Hedge fund-like Ellington Financial (EFC) is one of my favorite mortgage REITs, and insiders, including the CEO, have been active buyers in recent months.

Small banks are seeing a tremendous amount of insider buying. Although we have seen a rally in many larger regional banks, many community banks have not participated in the rally and are still very cheap. Most of the real bargains are too small to write about here, but if you are not investigating what the officers and directors at small local banks are doing with their money, you are making a mistake. Small one- and two-branch banks where insiders are adding to their already large positions in their own stock have been very profitable investments for over the years. Given the merger & acquisition activity in the small bank sector, now should be an even more lucrative time than in years past.

Hotels were one of my favorite investment sectors coming into the new year, and there's buying in two of my favorite names.  Red Lion Hotels (RLH) continues to see consistent buying by Columbia Pacific Opportunities Fund. The fund now owns more than a quarter of the Northwestern U.S. hotel operator.

Chatham Lodging Trust (CLDT) officers and directors are buying as the hotel business enters the early stages of a turnaround. At 80% of tangible book value, I like this stock as a play on the recovery of the mid-market hotel business.

FelCor Lodging (FCH) is my favorite longshot pick in the hotel business, and the company saw a flurry of year-end buying by executives and directors. Hotels have been the hardest-hit segment of the commercial real estate market and the recovery will be slow, but the next decade should reward patient insiders and investors alike.

I was surprised not to see more insider buying in natural gas-related companies that have fallen below tangible book value. Natural gas has been a disaster so far in 2012. Excess supplies and weak demand have driven prices below $3 per 1,000 cubic feet. Natural gas exploration and production companies have seen their prices follow commodity prices lower. Although there has been a little buying in some small companies, so far only one of the larger natural gas companies has seen strong insider buying.

Chesapeake Energy (CHK) has seen its stock drop by more than 25% in the past few months. The stock now trades at just 80% of tangible book value. The decline has the attention of insiders as officer and directors, including CEO Aubrey McClendon, have been opening their checkbooks and buying shares. Eventually, natural gas will become a larger part of U.S. energy policy and we will see more gas-fired generation facilities, manufacturing plants and even vehicles. Patient buyers, like the insiders at Chesapeake, should see their investments climb by multiples of today's low price.

Combining valuation and insider activity has been very successful for me in the past; I see no reason why it will not continue to work that way in the future.

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