Pssst. Want a good stock tip?
Check with the insiders. NOT the insiders whose "tips" can get you thrown into jail, mind you...
(For his part, ImClone founder and CEO Samuel Waksal was arrested in 2002 on insider trading charges after instructing friends and family to dump ImClone shares before the FDA decision was made public. In the end, Stewart didn't face insider trading charges but did serve five months in prison on related findings.)
No, I'm referring instead to company insiders – officers, directors and holders of large blocks of stock who are required to report stock transactions involving their company to the U.S. Securities and Exchange Commission (SEC), which in turn makes those transactions public.
You see, especially when it comes to insider buying, there's evidence to suggest it can pay off for investors who are paying attention. And it's all perfectly legal.
Keeping Up With The Insiders
As far as stock-market indicators go, you could do worse than simply keep tabs on what company insiders are up to.
After all, they are on the front lines. Who else would better know the company's prospects? They are privy to information regarding new products, competition, and the overall operating environment of the firm – the ultimate due diligence, if you will.
And there's money to be made. The Insider Fund, a long-short insider-tracking hedge fund managed by Park City, Utah-based Alpha Wealth Funds, has crushed the S&P 500 by three to one since 2001. The Catalyst Insider Buying Fund (INSAX) has outperformed the market by nearly nine percentage points the past 36 months.
Catalyst Insider Buying Vs. The S&P 500
There is a slight catch, however...
Research has shown that insider buying is more useful than insider selling in predicting future returns, outperforming the market by over 7% annually in one 10-year study.
This only makes sense when you really think about it... Insiders who are buying their company's stock would likely not put up their own money unless they believed the investment would be profitable. At the same time, a decision to sell shares to raise cash could be based on any number of factors – a pending big personal purchase, a divorce settlement, a loan payback, to name a few.
Of course, it's not wise to base your buy and sell decisions solely on insider data. But it doesn't hurt to see what the inside money is up to. And because of the tendency for insider buying to be a good indicator for future returns, I went in search of companies with a significant level of insider buying.
Let's Follow The Insiders' Lead
More than 80 stocks initially filled the bill, defined in this case as at least three insider buys in the last six months. Of course, these companies also had to have had more shares purchased by insiders than were sold by insiders in the last six months. I also limited my search to small-cap stocks, those with a market capitalization of between $250 million and $2.5 billion.
But not all insider buying is equal... I then went through these 80-plus stocks to weed out ones that were recently listed, as this would skew the results since there will be more purchases and options exercised leading up to the initial public offering. I also made sure that the insider transactions were actually purchasing the stock, not just being "acquired" due to stock compensation or option exercises. It's obviously more meaningful when insiders are putting their own money to work as opposed to shares being "given" to them.
This left me with 22 stocks, which you'll find in the table to the right.
I didn't roll up my sleeves and do a deep dive into all of these stocks, but a few stood out. Also, please keep in mind that the investing ideas I present here are intended to provide a starting point for further research, not a final recommendation.
With that said, let's take a closer look...
1. Hyster-Yale Materials Handling (NYSE: HY) -- I know this name from my days running a forklift for my father's small feed and hardware store. The company manufactures forklifts and other lift trucks as well as an array of attachments, fleet management services and a variety of other power options for lift trucks.
The company generated more than $3.1 billion in sales last year and $34.7 million in net income. It also generated $28.8 million in free cash flow. It sports a 2.3% dividend yield and has grown its dividend at an average annual rate of 21.7% over the last five years.
The month of July saw massive insider buying. More than 2.3 million shares valued at over $1 million were scooped up. That's a lot of shares for a company that's valued at $900 million.
2. Myovant Sciences (Nasdaq: MYOV), based in the United Kingdom, is a clinical-stage biopharmaceutical company that focuses on developing and commercializing therapies for the treatment of women's health and endocrine disease, which affects hormone levels. The company is also developing a drug to treat female infertility.
Because this is still a clinical-stage company, it doesn't have any products on the market, and thus has no sales to report. So, it's a very speculative play, as reflected in a share price that has tumbled more than 50% this year. Not only have insiders been buying shares, but private equity firms have taken a considerable stake in the firm as well.
3. Majesco (Nasdaq: MJCO) is a global provider of cloud insurance software services for insurance companies. It provides the technology and expertise that help insurers modernize, innovate and connect to people and businesses. Some of its customers include MetLife (NYSE: MET), Progressive (NYSE: PGR) and New York Life.
With a market cap of only $360 million, Majesco pulled in more than $140.5 million in sales in fiscal 2019 ended March 31, a 14% increase over the prior year. It has a strong balance sheet with more than $33 million in cash on hand versus $5.4 million in total debt. What's more, this small company was able to generate over $6 million in free cash flow in its most recent fiscal year.
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