- Year to date underperformance vs. S&P 500.
- Price to Earnings (or normalized free cash flow in the case of SGMS) of less than 10x.
- Share buybacks within the past 6 months.
- Insider buying within past 2 weeks.
There is an old expression that goes something like this "while there are many reasons insiders sell, there is only one reason they buy". The combination of insider buying with a low valuation and share buybacks is likely to be a recipe for investment success. Today I will profile three companies which meet the following criteria:
- Price to normalized earnings (or free cash flow in the case of Scientific Games) below 10x
- Insider buying in the past two weeks
- Share buybacks in the past six months
- Under-performance vs. S&P 500 over past year
Altisource Portfolio Solutions (NASDAQ:ASPS) is down 48% from its 52 week high and now sells at less for 10x 2014 expected earnings. ASPS provides a myriad of real estate related services under a long term agreement with Ocwen Financial Services (NYSE:OCN). The stock has been crushed this year as NY Department of Financial Services Chief Ben Lawsky has begun a probe into the relationship between ASPS and Ocwen from which it was spun off several years ago. While it is possible that there will be some incremental changes to the contract between Ocwen and ASPS, I think it is unlikely that this probe yields anything which materially disrupts ASPS's business model (many real estate service companies earn 20-30% operating margins which suggests that ASPS is not over charging). Evidently insiders agree - in the past week two board members purchased $230,000 worth of stock. In addition, ASPS bought back $130 million worth of stock in the first half and recently increased its credit facility to facilitate further share buybacks. While there is currently a moratorium preventing Ocwen from purchasing any more mortgage servicing rights, I expect that this will eventually be lifted which would be beneficial to ASPS. As Ocwen grows its servicing portfolio, this significantly expands ASPS's revenue opportunity. I wouldn't be surprised to see ASPS earning $15-16 per share looking out to 2016-17 (factoring in growth in properties serviced and a 20% reduction in sharecount via buybacks). A fast growing, high margin, asset light business should certainly garner at least a market (16x) P/E multiple. Applying a 16x multiple to $15 per share in earnings gets me to $240 per share or nearly triple the current price.
The pending acquisition of Bally Technology (NYSE:BYI) by Scientific Games (NASDAQ:SGMS) will create a powerhouse in the gaming supply industry. Despite the creation of an industry juggernaut, SGMS shares have had a rough ride in 2014, falling 54%. While investors are concerned about weakness in the regional casino business and the company's high debt level, they are overlooking 1) high level of recurring revenue (50-60%) (2) #1/2 market position in several key categories (3) and potential for significant synergies. If the management is able to execute its merger plan, SGMS equity would be trading at less 2x free cash flow per share (click here for a more information on SGMS as well as a pro-forma financial model). Apparently insiders believe in their strategy - CEO Gavin Issacs recently purchased over $300,000 worth of stock. While highly levered, SGMS could be a multi-bagger if management delivers on its plans.
Herbalife (NYSE:HLF) remains a very controversial stock and shares have fallen 34% year to as the FTC investigation drags on. Herbalife trades at just 7.5x 2015 expected earnings. Better yet, the company deploys almost all of its free cash flow to repurchase shares. Assuming that free cash flow is roughly equivalent to net income, this means that Herbalife can repurchase 13% of its stock per year. Even if its business operations remained flat, by repurchasing 13% of its share per year, HLF is able to grow earnings at 15% per year (=1/0.87). Given the global obesity epidemic and Herbalife's success in expanding its business over the past decade, I expect that the company will be able to grow operating income 5-10% per year. Coupled with the share buyback dynamic outlined above, this will enable it to grow EPS 20-25% per year. There is an interesting paradox here - having an activist short seller like Bill Ackman (coupled with FTC is depressing share price) is actually accelerating Herbalife's EPS growth. Were the stock trading at 16x earnings, it would only be able to repurchase 6% of its share per year (which in isolation would cause EPS to grow a bit better than 6% or 11-16% after factoring in the growth of its underlying business). This makes Herbalife a very dangerous short (40% of free float is sold short). Insiders seem to be true believers in the Herbalife business, with six separate insiders collectively scooping up over $2 million worth in the past two weeks.
Though these stocks have been underperformed thus far in 2014, given low valuations, accretive share buybacks, and votes of confidence from insiders, I expect to see material outperformance over the next 2-3 years.