Get on the Insider Track

 | Dec 16, 2011 | 3:00 PM EST
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While writing my recent series of columns on real estate, I talked about insider buying as a clue to which distressed companies might be candidates to survive and thrive. In keeping with my personal motto to invert, always invert, I spent some time this morning looking for companies where insiders have been selling stock recently.

I wanted to see which of the darling stocks that have been climbing this year in a difficult market are seeing insiders cash in.

While it's true that there can be many reasons for an insider to sell, such as estate planning and diversification, it's also true that insiders often look at the valuation of their stock and decide if it is too rich and to take some money off the table. If the people that control a company are selling, I probably don't want to be a buyer or owner of the stock.

When I look at the list of stocks that are seeing insider selling, one that leaps out is Whole Foods Market (WFM). This is almost a classic value-investing story. In 2008, when the economy was heading off a cliff and the stock price was in the single digits, private-equity firm Leonard Green & Partners invested $425 million in the form of preferred stock that was eventually converted into common shares. Two members of the firm, Jonathan Sokoloff and Jonathan Seiffer, were elected to the upscale grocer's board. Since 2010, the PE firm has been cashing in on its investment, and this month sold another $46 million of stock. This follows a $179 million stock sale last month. In addition to private-equity investors, several officers and directors have been selling stock in recent weeks.

Whole Foods is a great company, and I believe that John Mackey is one of the best CEOs in American business right now. My wife and daughter love the store and drag me there as often as possible. However, you can pay too high a price for even the best companies, and at 34 x earnings, I suspect the current quote for shares of Whole Foods is far too high to justify a long-term investment. If I owned the stock, I would be trimming my position here just as the insiders and private equity investors are doing after the price has risen almost 40% this year.

Hansen Natural (HANS) is another growth darling that is seeing a lot of insider selling. The company makes energy drinks, most notably those sold under the Monster brand. However, we have seen large blocks of stock sold by both the chairman and vice chairman. Earlier this year, several officers and directors were selling stock in the open market. Bulls like that energy drinks are selling well, and Hansen is expanding overseas so European teenagers can stay up for three days playing video games. But I think this is all baked into the stock price. The shares trade at 35x earnings. In addition to the insider selling, I would point out the board is buying back stock at an enterprise value/earnings before interest, taxes, depreciation and amortization ratio of more than 16x, and more than 8x book value, even as board members sell their personal shares. I'm not a fan of stock buybacks at nosebleed valuations -- especially when board members are selling what they are buying with shareholder money.

I've saved the best for last. I have been short shares of Apollo Group (APOL) for almost two years. Every time the stock has popped, I have gone shopping for put spreads. I was recently asked how long I intended to stay short the shares and I always have the same answer: When the stock trades in the single digits at a discount to the net cash balance, I will close my short. The for-profit education business may have lobbied away the toughest regulatory changes this year, but that game is in the early innings. The charge-off and drop rates are astronomical, and as the largest player in the industry, Apollo will eventually spearhead a sector crash in for-profit universities. Insiders appear to be well aware of the risks, as they have sold more than $165 million worth of the stock so far this year. This month we have already seen more than $10 million of insider sales. I can go on about all the reason not to own this stock and to short the shares, but I'll run out of space. For now, take your cue from the insiders and be a seller of Apollo Group.

Most of the time, I prefer not to buy what the people controlling the company are selling, even if it is a good company. A great company does not always have a great stock price, and insider selling can help identify the times when that is true.

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