What would compel insiders to buy up company stock? After all, they typically receive shares anyway through annual stock option grants -- for free. Some market watchers suggest that these folks buy stock simply as a public relations gesture to show their support for the home team. I've never bought that line. Who would be foolish enough to commit funds to a stock that may be headed lower?
Instead, these insiders should be treated as a sign. They don't always have the ability to signal that a stock has truly bottomed out -- the broader market takes care of that. But they can at least clue us in that there may be some real merits to the stock at current valuations, even if few people outside the company think so.
Here are three beaten-down stocks insiders are loading up on...
1. RadioShack (NYSE: RSH)
The electronics retailer has become widely reviled by the investment community for a long string of weak quarters. We've already seen companies in this space such as Circuit City and CompUSA go broke, and the stock price chart may be implying a similar endgame for RadioShack.
Yet, in the final days of July, seven company insiders stepped in and bought a collective 220,000 shares at an average price of $2.53 a share. This caused the stock to rebound a bit to around $2.81, and it is currently trading at about $2.90.
Right as those insiders were buying, media reports were circulating that RadioShack may be headed for deep financial distress. But is that really the case? Sure the company's $680 million in short-term and long-term debt is worrisome, but RadioShack does have more than $500 million in cash. And the company's $800 million in inventory could be used as collateral with factors (firms that lend against secured assets), so talk of bankruptcy filings appears nonsensical.
The key is to see how management plans to turn things around. That insider buying is likely to be paired with restructuring efforts, so this is a name worthy of further research.
2. Pinnacle Entertainment (NYSE: PNK)
Four different insiders bought a combined 55,000 shares (at an average price of around $9.50) in late July of this operator of casinos in the U.S. Gulf Coast and Nevada. Pinnacle has delivered mixed results in its financial reports in recent periods, as ongoing investments in new or upgraded casinos have dampened cash flow.
Insiders have been buying up shares over the years, especially after they began falling from the mid-teens in early 2011 to the recent $10 range. This stock meets another criterion I like to see: The company announced plans to buy back up to $100 million in stock, shrinking the share count by more than 10%. Also of note: Pinnacle has exceeded EPS forecasts by at least 30% for four straight quarters.
What will get this stock moving back toward the mid-teens? The winding down of its various investments in new or upgraded facilities should allow free cash flow to finally shine. The company has generated negative free cash flow for five straight years while it has been in growth mode, but management appears to be committed to generating positive free cash flow starting in 2013.
3. Overseas Shipholding Group (NYSE: OSG)
The shipping industry is still recovering from the Great Recession of 2008-2009. Not only has demand remained below prior peak levels, but many ships began construction five years ago and ended up creating a glut of excess of capacity.
You can spot ugly stock charts across the board in this sector, and OSG's five-year chart is as troubling as any.
Overseas Shipholding has the added pressure of a very weak balance sheet, and some have expressed concerns that the debt load will eventually render the stock completely worthless. The only solution: asset sales and debt restructuring.
In that light, it's noteworthy that company director Thomas Coleman just announced a purchase of 100,000 shares at $5.82 apiece. That's the biggest open market purchase he's made in at least a decade.
Analysts at Dahlman Rose draw a clear conclusion: "We view this as a signal that a positive resolution with its lenders is on the horizon." They add, "An agreement with its lenders and/or a sale of certain business units should have a substantially positive impact on the shares."
Investors still need to do some homework on this one. The de-risked balance sheet is helpful, but industry dynamics need to improve for this stock to really get moving. In a second-quarter report on Aug. 1, management conceded that any discussions with lenders should be viewed in order to help OSG "manage through an extended downturn." So think of this as more of a potential trade on the debt restructuring than an investment right now.
Risks to Consider: Insiders have a poor sense of timing and are sometimes a bit early with their purchases, so be prepared for more possible downside in the near term.
Action to Take --> Over the longer term, these insider buying signals can yield big gains. That makes this a good time to dig more deeply into these fallen stocks, as operations may be on the mend within a few quarters.