Follow the 'Smart Money'?

 | Apr 08, 2013 | 9:30 AM EDT  | Comments
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If you consider insiders to be the "smart money" -- and there is evidence for that case --  then what they are doing should be important to your investment thesis.

I could argue that insiders are the "informed" money rather than "smart", but in either case their actions can be useful. When insiders buy for their own accounts, that is a strong signal. When insiders buy for the corporation they run, that may still be useful information, although less powerful. After all, it is other people's money they are using when executing a corporate buyback. 

There is plenty of evidence that corporate buybacks often happen at the wrong time -- too many shares purchased at too high a price, for instance. This matters if the buyback is an attempt by management to indicate undervaluation of their stock. It matters less if the buyback is simply a substitute for a dividend payment, in essence a return of cash to those who are OK with the associated tax liability.

Raymond James reports that Q1 was one of the strongest quarters for buybacks ever. They tracked 157 authorizations totaling $143 billion of potential purchases, with the consumer discretionary sector leading the way with 38 authorizations for $41 billion. The financials and tech sectors also had large authorization activity.

Importantly, the authorizations are driving excess performance. RJ notes that companies announcing buybacks outperformed the S&P 500 by 340 basis points, on average, for the month after the announcement. Energy and industrial names in particular reacted well to authorizations, averaging around 700 bps post-announcement outperformance. Only telecom companies showed poor performance post-announcement.

I see no reason for this trend to reverse. The market is interpreting buyback announcements as indicating a high level of confidence by management in their company's outlook. The quick lesson is to study closely any company making a buyback authorization, and consider a position for quick long trade. 

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