A Winning Combination for Value-Seekers

 | Jul 10, 2013 | 4:00 PM EDT
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Today I want to continue looking at insider trading in combination with other factors. A lot of research has been done on fundamental factors and on insider trading, but so far it seems that only H. Nejat Seyhun, now of the University of Michigan, has done a lot with combining those elements.

In his book Investment Intelligence From Insider Trading, Seyhun examined insider buying in stocks that trade below book value. He found that high book-to-market ratios (low price-to-book ratios) were predictive of future returns and outperformed high book-to-market stocks by a wide margin. He also found that monitoring insider trading could help outside investors predict future performance. In my many years of practice I have found this to be true, and I have a higher degree of conviction when buying cheap stocks that have insider buying.

This morning, I looked for stocks that have both characteristics. I was pleased to see that many of my current holdings are showing buying activity by the officers and directors who run the business. Synovus Financial (SNV), Berkshire Bancorp (BERK), Trans World (TWOC), BSB Bancorp (BLMT) and Richardson Electronics (RELL) are all seeing positive activity by insiders. The brokerage and banking concern SWS Group (SWS) is also seeing continued insider buying while the shares are at just 50% of tangible book value.

So are many of our alternative income selections in the mortgage REIT space, such as Annaly Capital (NLY), Armour Residential REIT (ARR) and Invesco Mortgage (IVR). The insider activity is reassuring, to say the least, and it makes me feel even better about my positions.

The mortgage REITs have been crushed in recent months by fears of higher interest rates and a tapering of Fed bond buying. Falling mortgage bond prices have caused some selling, as these vehicles are highly leveraged, and these trusts need to reduce positions to maintain leverage ratios. The managers of these trusts seem to have a high degree of confidence that they will navigate the difficult waters, and they are backing their convictions with cash.

Another income-oriented buy of interest is Alliance Bernstein Income Fund (ACG). The closed-end fund invests in fixed-income investments from around the globe, including government bonds, junk bonds and high-grade corporates. According to Alliance Bernstein's website, the net asset value of the shares is currently $8.28, compared with the current quote of $7.26. Insiders seem to think they have a handle on how interest rate moves will move the global bond markets, as four of them have purchased a total of more than $1.4 million worth of the fund in the past few weeks. The fund is currently yielding 6.6%, and the discount is more than 3 times the 10-year average and 50% above the five-year-average gap.

BRT Realty Trust (BRT) is a stock in which I have a small stake as well, and it is seeing strong insider buying in recent weeks. The REIT makes bridge loans that have maturities of six months to one year in term, secured by commercial and multifamily real estate. Right now, BRT has 12 loans outstanding in six states, and the bulk of the properties are in the New York City area. BRT is also involved in some joint ventures that acquire multifamily housing projects and other select real estate assets. The shares have moved up a bit but still trade at just 80% of tangible book value. The REIT attracts little attention from investors, as it does not pay a dividend and probably will not do so for several years.

The company has a stake in Teachers Village, a large, mixed-use project in Newark, N.J., that could have tremendous upside. The project will include retail space, apartments and schools. Investors in the project include Goldman Sachs (GS). Newark is attempting a renaissance under Mayor Cory Booker, and any degree of success in the effort adds to the value of these properties.

BRT insiders have been buying. In the last few weeks, four insiders, including the president and chairman, have combined to buy an additional $162,000 of stock in the open market. Some fairly bright value types have noticed the value as well: Both Michael Price and Royce Funds have bought shares in the past six months.

Academic studies confirm that combining asset value and insider buying is predictive of future returns. Common sense would seem to confirm it as well. It just makes an enormous amount of sense to buy undervalued assets in partnership with those who control the future of the particular assets.

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