Sharing Your Enthusiasm

 | Dec 06, 2012 | 3:30 PM EST  | Comments
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Stock quotes in this article:

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Before I move on from the subject of insider buying, I decided to run one last screen for insider activity. One of my favorites searches for what I call "perfect stocks," which, in my world, trade below tangible book value, are profitable and pay a dividend. This has been a fantastic screen over the years, producing wildly profitable stocks. The final criterion is usually a high level of insider ownership, but I decided to replace that with insider buying in the past couple of months and see what we found.

The first observation is that there is a serious struggle between Wall Street and insiders over the fate of mortgage real estate investment trusts. The conventional wisdom on mortgage REITS is that their run is over and the sector is too risky. The bear argument is that low mortgage rates are compressing spreads and making it very difficult for the mortgage REITS to maintain their dividends. The housing market is stabilizing somewhat and we are seeing refinance activity that pays off higher-yielding bonds earlier than expected. Meanwhile, home sales are still sluggish so not much new paper is being purchased. As a final bear blow, the Federal Reserve is now a major competitor for what paper is issued, as they are buying $40 billion a month of mortgage paper.

The argument seems to make sense and we have seen several mortgage REITs cut their dividends. So why are the folks running these firms such enthusiastic buyers of their own stock? Three of the 10 largest insider buys by dollar volume on my list are mortgage REITs. Officers and directors at ARMOUR Residential (ARR), Hatteras Financial (HTS) and Two Harbors (TWO) have been sizable buyers in the open market. Richard King, CEO of one of my favorite long-term mortgage REIT holdings, Invesco Mortgage Capital (IVR), has been an enthusiastic buyer of his own stock in the past month. Someone is very wrong in this sector, and although they may be early, I do not think it is the insiders.

The second thing that is apparent from the list is that the executives and board members of small regional and community banks share my belief in the Trade of the Decade. The vast majority of the bank stocks on the list are too small to talk about here but a few names standout. Westfield Financial (WFD) is one my favorite post-thrift-conversion bank stocks and one of its executives purchased 30,000 shares in the open market recently. A director recently picked up 25,000 shares of New York-based Astoria Financial (AF), another stock I have owned for some time. First Bancorp (FBNC) is growing through acquisitions and FDIC-assisted purchases of failed banks. The credit picture is improving, and the CEO Richard Moore seems to believe better days are ahead for the North Carolina-based bank. He recently went into the market and increased his personal stock holdings by 10%.

Positive news about strong sales of Gorilla Glass recently led to a nice pop is shares of Corning (GLW).  I still like the stock and, so does at least one insider. One director recently opened his checkbook and bought 170,000 shares. This company is in all the right industries for the next several years as its glass products are used in smartphones, flat screens, tablet computers, biotech research and clean-air technology. The stock is cheap and the company is poised to be a growth leader over the next five to 10 years. I am happy to see that the folks running the company agree with my positive outlook.

Two insiders, including CEO Patricia Woertz, have been buying shares of leading grains processor and transporter Archer Daniels Midland (ADM). The shares have been trading right around book value and some insiders seem to believe that is cheap enough to be attractive as a long-term investment. Rising global demand for food will eventually drive earnings and the stock price of this company much higher and it is on my buy list for a substantial market decline. If I could get the stock at less than 80% of tangible book value in a protracted market decline, I would be a wildly enthusiastic buyer.

The exercise of combining perfect stocks and insider buying didn't provide much in the way of new information or opportunities, but it did confirm that we are on the right track with many of our investments. The people running many of our portfolio companies like them as much as we do.

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