Targeting When the Top Dogs Buy

 | Jun 22, 2012 | 2:00 PM EDT
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For longtime readers, it should come as no surprise that, in addition to reading everything I can get my hands on, I am a big fan of playing around with numbers and data in order to find things that work in the markets. Over the years I have had countless epiphanies that have been subject to my crude testing skills. Most of them did not work. Some did, and while there is no Holy Grail of investing, I have discovered what I like to call "pretty nice chalices." I've been searching around the databases maintained by fellow Real Money contributor Jon Moreland, of Insider Insights, and this has provided one such idea that appears to work very well, and is a tool for traders and investors alike.

The idea was simple, but the results were stunning. I tested the idea of buying stocks in the database that had large insider buying by the two top executives. When the CEO or CFO broke out their checkbook and bought shares in the open market, good things happened to the stock price. In 2011 we saw 33 qualifying trades -- and 25 of 33 were positive, with an average gain of 31% by year-end. In 2009, 16 of 19 trades were positive, with an average gain of 72%. The difficult years of 2009 and 2008 also saw very large average gains and a high percentage of profitable trades.

This year has been running true to form: 31 of the 49 qualifying trades are positive, and the average gain is a little over 70% so far. Perhaps what can explain this is that the CEO and CFO see more of the big picture and more financial information about their company -- and, as a result, they are typically in the best position to make a judgment on their company's future. We have seen some interesting buys in the past few weeks by the two head honchos of some companies, and these stocks may be worth buying for gains by year-end. They also look cheap enough to be considered as long-term investment opportunities.

Arbor Realty (ABR) is a stock I have owned for some time now. The company invests in commercial real estate projects and securities as both a debt and equity investor. Arbor has survived the worst of the credit and real estate crisis, and it has completely revamped its balance sheet over the past two years, reducing legacy debt and writing down or monetizing problem loans and properties.

Arbor, a real estate investment trust, has recently moved into investments related to residential real estate -- to the tune of some $65 million so far. It expects these investments to yield returns of 20% or more. On a recent conference call, CEO Ivan Kaufman estimated that Arbor's net equity value was approximately $500 million. With its current market capitalization at slightly less than $150 million, it is not surprising that he has been buying shares of his company. Following the recent equity offering, Mr. Kaufman has purchased 55,000 shares of Arbor shares in the open market.

Hercules Offshore (HERO) is another stock that has seen buying by its chief executive. I have had a small position in the stock since 2010, and I've taken a round trip with the stock, having missed the opportunity to take large profits earlier this year. The shares are now back down near my original purchase price, with lower oil and gas prices having depressed the world's fourth-largest provider of shallow-water drilling rigs.

Hero is also the largest provider of liftboat services to the drilling industry. The company has engaged in a series of equity offerings and debt refinancings that have improved the balance sheet and pushed significant debt maturities back to 2017. The company may struggle in the short term -- but when energy prices firm, the earnings and stock price could recover sharply. CEO John Rynd certainly seems to think so, as he recently purchased an additional 30,000 shares of the stock.

In sum, insider buying has long been a positive indicator for the prospects of a company, but narrowing the focus to large buys by the top executives has provided superior historical results. I have no reason to believe this won't be the case in the future.



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