During an average day, I communicate with a wide range of people to talk about stocks, markets, baseball and books. Most of them have similar value inclinations as I do, so I also talk to traders, growth folks and even the occasional arbitrageur. I have found that being aware of various approaches and viewpoints can help make me a better value investor. Last night I was talking with an old friend who primarily trades options in individual stocks and he talked at length about his success buying calls on stocks that had high short interest and recent insider buying.
I have no intention of trading short call options on anything, as the stress of having a time-dated position would drive me mad in relatively short order, but I was intrigued by the possibility of using it in a value screen. So I ran a quick screen for stocks trading below book value that have a high short interest and recent insider buying. It produces an intriguing list of stocks.
A.M. Castle & Co. (CAS) is in the metals and plastics businesses. The metals division of the company engineers and distributes alloy, aluminum, nickel, stainless steel, carbon and titanium. The plastics division distributes plastics in forms that include plate, rod, tube, clear sheet, tape, gaskets and fittings. The shorts must feel that the weak economy will keep a lid on business at the company as there are some big short-side bets against it. Almost 30% of the float is currently sold short.
So far in 2014, they have been correct, as business conditions have been difficult. Moody's recently downgraded the company. The report issued by the ratings agency noted that results have been "very weak driven by competitive market conditions, market share losses, severe winter weather, and uneven demand across key end markets, and execution issues related to branch consolidations, systems conversions and inventory management. As a result, the company's revenues have declined by about 13.5% to $990 million and its adjusted EBITDA has plunged 77% to $12 million during the LTM period ended June 2014 versus the prior year period."
So far in 2014, the stock is down more than 50%.
Insiders seem to feel that conditions will improve before much longer. CEO Scott Dolan has been a consistent buyer over the past few months with his most recent purchase just a month ago. One other officer has also been buying shares of the beaten-up stock in the past month as well. If they are right about improving conditions, the shorts could quickly get squeezed out of the stock, creating a pop in the share price. Trading at less than 80% of book value, the stock could have substantial upside once it starts moving in the right direction.
I haven't pulled the trigger on Titan Machinery (TITN) yet, but continued weakness in the stock has me close to adding it to my collection of undervalued stocks. Titan owns and operates a network of full-service agricultural and construction equipment stores in the U.S. and Europe. Lower commodity prices have hurt the agriculture segment of the business as farmers delay large capital outlays and the international segment of the business has been hurt by continued weakness across Europe.
The shorts have noticed the weakness in the business and taken advantage of the poor short-term outlook. Thirty-one percent of the float is sold short in a bet that the weakness continues and, right now, it would take more than a month's trading volume to buy back all the shares sold.
The man running the company has a different outlook for the company and the stock it seems. In September, CEO David Meyer bought an additional 90,000 shares of Titan stock for more than $1.1 million. He already owned more than 600,000 shares, so he must feel that the stock price is getting near a bottom. With Titan Machinery trading for just 71% of book value, any good news that sends shorts scrambling to buy back shares could start a long rally and big gains for the stock.
Talking to many different people with differing viewpoints during the day can open us up to ideas that we can use as long-term value-oriented investors. The idea of looking for cheap stocks, high short interest and recent insider buying appears to have substantial merit.