Dear fellow investors,
We often take for granted all the technology at our finger tips and have forgotten how much information was available to us in the form of papers and books. One example are stock charts which regularly came to us in a book called, Daily Graphs. Each time we received an updated copy, we scoured the charts looking for stocks which had drawn much attention from the officers and directors. Nothing was more interesting to us than a stock which had an abundance of insider buys, which we called a “blizzard” of buys.
The insider activity was shown on the stock chart via circles with either a minus sign for sales above the circle or a plus sign above for buys. When there were 10 or more insider buys in a three to six-month period, it made it look like a snowstorm of buy orders, hence the name “blizzard” stocks. Why was this important?
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Back then, the most successful portfolio manager in America was the Fidelity Magellan manager, Peter Lynch. Lynch liked to buy stocks which had little institutional ownership, were ignored or hated by Wall Street analysts and had seen significant recent insider buys. In his book, One Up on Wall Street, he explained that there were as many as 50 reasons for an insider to sell a stock. They could buy a house, pay college tuition or fund the new business of a relative. Lynch felt strongly that the insiders were the best at determining the value of the business and if they were buying aggressively, either in size or in the form of numerous purchases by multiple insiders, it was an especially strong buy signal.
Today, insiders are required by Federal securities laws and rules to file a Form 4 with the SEC within two days of their purchase and you can go to any number of websites to find out what insiders are doing on a day-to-day day basis. This information is available to everyone, but as Lynch pointed out, few investors tend to give it the level of importance he (and we) think it deserves.
For example, in the summer of 2012 Jamie Dimon, the CEO of JPMorgan (JPM) bought over $17 million of his own company shares at $34.22 per share. JPMorgan stock had taken a nose dive because a rogue trader had blown over $6 billion on what ended up being called “The Whale Trade.” What do you think investors who knew Jamie Dimon might have done with that public information?
As an investor, you may view this purchase as a sign to buy as well. On December 27, 2019, those shares were trading at $139.14 and the company has paid $15.46 in dividends since then. Just for the record, he bought even more later ($27 million) around $53 per share.
Some other historical examples would be helpful. Security Pacific was a major West Coast bank in 1992 and there was a blizzard of insider buys early in the year. Six months later it got bought out by a predecessor of Bank of America (BAC) at a 50% premium to what the insiders had paid. More recently in 2012, we spotted heavy insider buying in Bank of America in the $7 to $10 range. BAC traded at $35.35 on December 27, 2019 and has paid a bunch of dividends since then.
IBM was a decimated stock trading at $50 per share in 1995 when Lou Gerstner came in from the outside to run the company. He hired Jerome York, the key financial executive of the Chrysler turnaround, and other talented execs to help him. Those folks practically backed the truck up to buy shares in one of the biggest blizzards we have ever seen. In 1999, the stock traded at $125 per share after a 4-for-1 stock split. In other words, in less than five years you made ten times your money. Why didn’t more investors use this public information to their advantage?
First, occasionally insiders are wrong. We were asked about this recently and the worst examples were in 2008. Insiders were attracted to lower prices and bought shares. Instead of 18-month gains, they got stuck with huge short-term losses. The poster child were insiders at Wachovia Bank, who bought millions of dollars of their own stock at $8 per share and got bought out soon after by Wells Fargo (WFC) at $2 per share. The value in the shares they saw couldn’t survive the circumstances of the financial crisis. Our guess is that Wells Fargo has made a ton of money from buying Wachovia since then. They picked up market share in the Atlantic region in banking and a wonderful financial adviser network that is integral to the way customers are handled today.
Second, the rewards are likely to come over longer stretches of time. We think the insider buys are most effective in 18 months than they are in 90 days. In fact, many times stocks move even lower after insiders buy. This discourages most investors. With the markets dominated by quant firms and technology trading, instant gratification is what folks want.
Third, a stock with insider buying isn’t always accompanied by our eight criteria for common stock selection. One of our criteria is strong insider ownership, preferably with recent purchases. We have seen heavy buying in a stock which might do well over 18 months but doesn’t appear to be a stock which has the potential to be a big winner over ten years. To practice low turnover, you must stick to companies of quality which can be held for a long time.
We believe the average U.S. large-cap fund spends about 81 basis points each year on trading, while we spend a fraction of that. This doesn’t count the tax savings of holding your gains away from where the IRS can get its hands on some of your hard-earned dollars.
There have been 23 purchases by 12 different insiders of Occidental Petroleum (OXY) beginning in June 2019 at around $50 per share and continuing to December 6, 2019 around $38 per share. They have invested $8,192,987 in the stock. Warren Buffett’s company, Berkshire Hathaway (BRK), bought preferred stock in OXY which gives the company warrants to buy 80 million shares at $62.50 per share. It appears that is not enough for Berkshire, because someone there started buying the common shares in September. We won’t know until they file their 13F in the first quarter how much they did or didn’t buy in the fourth quarter of 2019. This is classic Buffett contrary investing in the energy sector, which is the most out of favor that sector has been in the S&P 500 Index in my 40 years of being in the investment business!
Macerich (MAC), an owner of Class A malls in attractive large cities, has also had a blizzard of buys. Six insiders have made 29 purchases beginning in May 2019 and carrying into November to the tune of $4,679,414. Like OXY, Macerich is deeply out of favor and owns very attractive physical assets. Macerich has had to deal with replacing low-rent tenants like Sears and JCPenney. However, rents go up quite a bit when those large end pieces of the property are redeveloped and rented out to a variety of retail and non-retail businesses at much higher rents.
Lastly, Discovery Inc. (DISCA) saw a blizzard of insider buying between $16-$22 per share in 2017 and 2018 in the aftermath of buying Scripps Network and borrowing a ton of money to do it. On November 14, 2019, the media mogul John Malone bought 2,670,000 shares at $28.03 per share for $74,840,100. Another director, David Wargo, followed the next day with a purchase of 162,450 shares at $4,594,086. By requiring the transactions to be filled publicly within two days, the Federal securities laws put investors on the same footing as people who know Jamie Dimon and John Malone. It’s just a question of who will trust the information.
We are very fond of buying stocks which have been the subject of a blizzard of insider buying affection and will wait patiently, like we have in the past, to see if Peter Lynch’s theory works as well today as it has before. Thanks for putting on your winter coats and joining us in this endeavor!
The information contained in this missive represents Smead Capital Management's opinions and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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