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  1. Home
  2. / Investing

Look for Skin in the Game

I'm a fan of buying stocks where management has a vested interest.
By TIM MELVIN Oct 09, 2014 | 02:00 PM EDT
Stocks quotes in this article: BRT, GIFI, GLF

Since there is no baseball until Friday, I spent time last night embracing my inner geek and caught up with the studies and reports littering my office. While there is a lot of stuff from academia that is close to worthless and only exists to satisfy the "publish or perish" mandate at most universities, finding something that helps us make more money in the markets more than offsets the hours spent skimming the bad ones. Near the bottom of the pile I came across a paper entitled "The Skin In The Game Heuristic for Protection Against Tail Events" by Nassim Taleb and Constantine Sandis. The general idea of the study was used in Taleb's book Antifragile, and discussed all over the Web, so I had not bothered to read the August 2013 paper yet.

While I won't bore you with the whole paper, I want to share one sentence from the abstract because it can make you a more successful investor. Taleb and Sandis say that they intend to "propose a global and morally mandatory heuristic that anyone involved in an action which can possibly generate harm for others, even probabilistically, should be required to be exposed to some damage, regardless of context."

If you apply that sentence to the market, it has huge implications. Does anyone think that we would have had a financial crisis if the big brokers and banks were still partnerships and it was partner's capital being used to create all those toxic time-bomb securities?

We can use it find winning stocks as well. I have said before that I am appalled by how few officers and executives of U.S. corporations own a significant amount of share in the companies they run. A quick screen of U.S. stocks shows that just about 10% of all publicly traded companies have greater than 10% insider ownership. The people running the show have little to no skin in the game. If they make mistakes and the stock craters, they don't feel your pain, nor do they have to give back the bonus they got last year. I would rather invest alongside people who have the same goals as I have, and benefit or suffer from price moves in the stock in the same way their shareholders do.

I ran a screen today looking for stocks that are sufficiently cheap and have a high level of insider ownership. Some of my favorite stocks were on the list, including BRT Realty Trust (BRT). This REIT has been transforming itself from a real estate lender to an owner of multifamily real estate. So far, it has accumulated a portfolio of 26 multi-family properties with an aggregate of 7,610 units. I suspect the fact that the officers and directors owning about 24% of the shares keeps them more focused on the transformation process. The stock is trading at about 75% of book value, so you can get your money in alongside management at a discount.

Two energy-related stocks that I have mentioned recently also have high levels of insider ownership. Gulf Island Fabrication (GIFI) builds platforms for the offshore oil and gas industry and, like so many oil and oil-services stocks, the shares have been dropping and are down about 25% so far this year. Officers and directors own out 10% of the company, and they will be more committed to managing though the downturn than non-owner management, in my view. The stock is getting close to too cheap not to own at 89% of book value.

Gulfmark Offshore (GLF) provides transportation services to the industry and has fallen to 70% of book value. Insiders won 11% of the company and have a vested interest in surviving until they thrive during the current downturn. If the oil slide continues, I will be a buyer of GIFI and GLF at these bargains levels.

I take insider ownership and trading very seriously, and I'm a big fan of buying shares of companies where management has skin in the game when they are trading at bargain levels.

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At the time of publication, Melvin was long BRT, although positions may change at any time.

TAGS: Investing | U.S. Equity

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