Long-Term Plays vs. Cluster Buying
By Graham Summers
January 18, 2007
More and more, I'm finding that insider purchases can be broken down into two categories:
1. Individual long-term plays
2. Cluster buying during special situations
You might already be familiar with the first group. In these situations, the insiders are usually one or two key high-level executives who have been with the company a long time.
The purchases tend to be large (millions of dollars) and indicate long-term growth potential in the stock. I found several of these types of opportunities last year for subscribers of Inside Strategist, most notably AutoZone (AZO), up 27%, and Oakley (OO), up 28%.
Purchases by investing legends also fall into the first category. You see, if a single investor, such as Warren Buffett, or investment firm owns more than 5% of the outstanding shares, they're considered an insider, even if they don't work at the company.
In these situations, you should buy and hold. You may not double your money in a year or less, but the long-term compounding return is the safest, best method of wealth generation. This is how Warren Buffett became the world's second-richest man.
The second form of insider purchases, cluster buying, is completely different. In these situations, you typically see three or more insiders purchasing stock directly before or immediately after an event that depresses the company's share price. The individual purchases are typically smaller in size, but the potential gains can be both large and quick.
The most common type of cluster buying occurs when a company misses its quarterly earnings estimates. When a company, for whatever reason, misses its quarterly earnings estimates or announces that its sales growth is slowing, shares can plummet 10%, 15%, even 20% in a single day.
While everyone else is dumping their shares, the insiders swoop in and buy. They know whether missed earnings are the result of a temporary issue or an actual problem with the company's business. And the selloff gives them the opportunity to purchase at a great price.
Following these transactions involves more risk, but the potential gains are well worth it. You can sometimes pocket 40% or 50% in a month or so. If the insiders are buying, you know the bad news is temporary.
Just look at Nvidia (NVDA), for instance. Back in August 2004, Nvidia fell short of analysts' earnings estimate by 80%. The primary reason for the miss was a delay in the launch of its newest line of graphics processing units (GPUs), and other tech software. It's difficult to make money when you're not selling anything. Investors took the setback hard, and Nvidia shares dropped 35% in one day.
And that's when the insiders started buying.
On August 12, Director Brooke Seawell bought half a million dollars' worth of stock. The next day, three other directors ponied up for a combined purchase of $9.6 million.
This buying frenzy continued for three weeks.
Altogether, insiders bought more than $20 million of stock in less than one month. At the same time, the company announced plans to buy back as much as $300 million of company stock.
Given the insider bullishness, as well as the fact that Nvidia was finally about to release its next generation of GPUs, I recommended the company to Inside Strategist subscribers in mid-September 2004.
We sold our positions three months later for a 67% gain.
The next time one of your stocks misses earnings, don't panic. Look at what the insiders are doing. If they're buying, you know the bad news will be short-lived. And the dip in share price gives you a chance to buy more shares on the cheap.
It's hard to buy a stock when everyone else is selling. But buying with the insiders can make it worth your while.
Good trading,
Graham
