Shift the Odds in Your Favor

 | Jun 03, 2014 | 3:00 PM EDT
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I want to follow up on the screen I ran in my previous column. Based on the idea that insider buying and low prices relative to book value both lead to high returns, I looked for companies that had both anomalies present. The idea is that finding stocks with two indicators that pointed toward outperformance should give us an edge over the market and improve overall returns. Insiders know more than anyone about the conditions and prospects of the companies they run, so when they are buying on the cheap it just makes a lot of sense to listen and act.

Over the years, I have found insider buying to be a powerful confirmation factor when considering a stock that traded below book value. I was happy to see that many of my current holdings are still very cheap, but insiders are starting to accumulate the shares. There is a tendency to worry when your stocks are not moving higher when the market is hitting all-time highs and insider-buying activity gives me the confidence I need to be patient with my holdings.

The biggest buying among stocks in my portfolios was Aircastle (AYR). Marubeni Corp. is a beneficial owner of the shares and has a seat on the board. Marubeni has been a continuous buyer of the stock since taking a 15.9% minority stake last year. The Japanese conglomerate now owns around 20% of the company. I am a big fan of the aircraft-leasing business and believe that it will continually improve over the next several years. In the meantime, Aircastle remains cheap with the stock trading at 81% of book value. As a bonus, you get paid to wait for the value to be reflected in the stock as the shares yield 4.8% at the current price.

Hercules Offshore (HERO) has seen continuous buying this year by Director Steven Webster, a managing partner at private equity firm Avista Capital Holdings. He has extensive experience in the energy field, so to see him cracking open his checkbook to buy the stock is encouraging, to say the least. Hercules is in the shallow-water drilling business and has a fleet of lift boats that deliver supplies and cargo to offshore drilling platforms. The stock is currently trading at just 80% of tangible book value, so there is a lot of upside when drilling activity picks up in the next few years.

Other cheap stocks that I have mentioned recently that have seen insider buying recently include Preferred Apartment Communities (APTS), Alpha & Omega Semiconductor (AOSL), Transworld Entertainment (TWMC) and BRT Realty Trust (BRT). All of them trade well below tangible book value, and the insider buying reaffirms my belief that much of that value will be unlocked over the next few years and will provide sizeable profits.

The second observation form the list of cheap stocks with insider buying is that the officer and directors at small banks are definitely on board for the trade of the decade. They seem to have a great deal of confidence that the price of their shares will rise to reflect the underlying value of the bank. I suspect that many of them are well aware that sometime in the next year or two they will get buyout offers from larger banks looking to grow assets and earnings in a marketplace that has no organic growth right now.

Waterstone Financial (WSBF) is a Wisconsin-based thrift that underwent second-step conversion in January and is now trading at about 80% of tangible book value. Two directors opened their wallets last month and bought shares of the bank in the open market. The bank has recovered from the hard hits its housing-heavy loan book took during the credit crisis and is now flush with capital after the offering.

The spring thaw must have Wisconsin-based bank insiders feeling confident as two directors of Westbury Bancorp (WBB) wrote checks to buy shares of the bank they control. The bank also just announced a 250,000-share-buyback program, which is about 4.9% of the outstanding shares. The stock trades for less than 80% of book value at this price, so it probably makes sense to join the directors and the bank itself in buying shares of Westbury at this level.

There a baker's dozen of banks on the list of cheap stocks with recent insider buying that are too small to list here, but it would be a profitable use of your time to screen for them as they are very much candidates for a trade of the decade bank stock portfolio.

Insider buying below book value can be a strong confirmation of the recovery potential of a bargain stock. Combining the two factors to improve your odds of investment success just makes sense to me.



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