December 7, 2001
THE INSIDERS SPEAK UP
Those of you who have followed me for a while may remember that my specialty is analyzing Insider transactions. (Insiders are high-ranking executives, directors, etc. within a company. When they buy their company's stock, it can be a very good sign.) I've been saying for a few years now, that following Insider transactions has less value than it used to, for two reasons: One, companies have figured out that people are watching their actions, so they encourage or force their executives to buy stock as a public relations ploy. And, two, the overuse of options compensation for executives makes it unnecessary for Insiders to buy stock to profit from its rise.
The tide changed this month, however, and I'm now getting very strong Insider signals, both positive and negative. Let's talk about the negative first.
For many years Insiders at high-tech companies have not been buying stock. In fact, they have been selling just about every single share they've received through their stock option exercises -- except in the few cases where they are required by their companies to hold onto some.
In general, Insider experts have considered this pattern to be a neutral indication. I was in that camp for a while, but was eventually troubled by the fact that virtually no stock was being retained. After all, even though executives know they're getting more options next year, you would think they'd hold on to at least a little of the stock if they thought it would appreciate -- but they didn't. A look at the P/E ratios of those stocks easily explains why a rational, informed investor (the Insider) would sell the stock. It was clearly and simply overvalued and therefore poised to fall, not rise.
Unfortunately, the average retail or mutual fund investor is not a rational investor, so he or she got walloped in high tech stocks in the last 18 months.Viewed another way, this whole recent debacle in tech stocks could be viewed as those in the know (the Insiders) selling their overpriced goods to the ignorant public. This is exactly how I view it. As I have lamented before, the situation is aggravated by the fact that the cost of the options is hidden from the companies' earnings statements, so the stocks were even more overpriced than they appeared … much more.
No Change of Heart
But what about now? These tech stocks are down 80% to 90% from their highs. Are Insiders buying them now? No.Tech Insiders are still not interested in their companies' stock. This despite the fact that the tons of stock options they've been issued in the last two years won't have a chance of appreciating in value until after these stocks move back up to their former prices. In other words, if these executives were issued stock options when the stock was $80 a share, and the stock is currently $20 a share, those options don't begin to accrue value until the stock recovers to $80.
It doesn't take a J.P. Morgan to figure out that if Insiders felt the stock had a chance of recovering to prior levels it would make sense to buy some at the current low price. Insiders, however, are not doing that. There's been a smattering of token buying in a few companies, and there has been Michael Dell's highly-publicized buy after the World Trade Center bombing. However, if you look closer at the numbers, you'll see that even after that "big" public-relations buy, Michael Dell is still a $180 million net seller of his company's stock in the last year. And it's no wonder. When a knowledgeable accountant examines the company's books closely, it is clear that the company's earnings are a lie. The unreported options expense is decimating earnings and cash flow.
A Different Story in Low Tech
Insiders' actions in other sectors -- the low-tech and no-tech sectors -- tell quite a different story. This month I've been inundated with Insider buying in many industries all across the economy. Small savings and loan companies predominate, as they have for months, but now I'm also seeing buying in other industries like hotels, temporary work agencies, utilities, and basic commodities like paper and metals.
This broad-based buying indicates to me that the economy should recover sometime in 2002, and that these companies are good buys at current prices. This is in marked contrast to the high-tech sector. Insiders there think their stock is overpriced, even factoring in recovery. Another conspicuous absentee from Insider buying is the energy companies, that is, those producing or marketing oil and gas. These companies generally give little in the way of stock options to their executives, hence, the Insiders at these companies tend to be more active buyers of their stock when they think it is undervalued. We saw a lot of Insider buying in the energy sector in 1998, for example, and those stocks soared over the next two years. Apparently, energy Insiders aren't convinced they've seen the bottom in energy prices yet, leading me to believe that the recovery in the economy won't be until late 2002.
Given that outlook, what does the landscape of the stock market look like for the next few months? Since the market discounts events many months in advance, and we've had a big run up in high-tech stocks, I'd say that it has already priced in a recovery in high-tech, but not in the more mundane sectors. High-tech will almost certainly have a big pullback when it is realized that the economy is going to recover more slowly and less strongly than expected. After pulling back in sympathy, the lower P/E stocks that have the Insider buying will move up.
Of course, it is possible we'll again get the degree of high-tech mania we had in 1999, and it will take longer to correct, but that will only make the correction more drastic when it comes. And just like in 1999, it makes sense to buy the good values the Insiders are showing us. They did very well in 2000 and 2001 while the overpriced tech sector bled green.
In the coming weeks, I'll have some stock recommendations from my recent Insider mother lode.
I'll talk with you again soon.
Copyright ©2008 by Jack Adamo. All rights reserved.