The recent market sell-off, however brief it was, has created some interesting opportunities for long term investors. In my view, there is no better confirmation that one has identified an undervalued security than to see insiders using their cash to purchase shares. Today I will share three inexpensive stocks that insiders have been purchasing shares lately. Here are my criteria:
- Price to normalized earnings of less than 10x
- Share price underperformance vs. S&P 500 over past year
- Insider buying in past month
Avnet (NYSE:AVT) shares, while up 8% in the past 52 weeks, have meaningfully lagged the nearly 16% return logged by the S&P 500. The company has two businesses: (1) it is a leading reseller of hardware/software for enterprises - including networking, PCs, servers, etc. (2) It is a leading distributor of electronic components (semiconductors are the main category) to a wide range of customer groups. The electronic distribution business represents the bulk of Avnet's business (70% of group operating profit). While operating margins in this business are low, returns on capital are high (20% after tax, excluding goodwill) as the company has numerous competitive advantages including purchasing scale, breadth of product offering (one stop shop for customers), strong infrastructure to allow for timely deliveries to customers. Further, if the company were ever to merge with competitor Arrow (NYSE:ARW), we could see an additional $250-300 million in savings (attributable to Avnet, I'd imagine the entire pot of savings would be $500+ million) which represents over 5% of Avnet's market cap (capitalizing these savings could add 40% to the share price). The company generates strong cash flow and has used it to make acquisitions and buy back stock. Recently, Avnet initiated a dividend. At 9x EPS, the stock materially undervalued - were it to trade at 14x, shares would appreciate by 55%. Earlier this week, Avnet disclosed that director James Lawrence purchased nearly $8 million worth of stock. This large vote of confidence from a board member makes me think that I'm on the right track by owning Avnet.
Titan International (NYSE:TWI) has badly missed earnings guidance this year sending it's shares down almost 20% year to date. Titan is a maker of wheels and tires primarily used in agriculture, construction and mining. While investors are concerned about weakness in the mining segment and a slowdown in the agriculture, several positives are being ignored including: 1) large percentage of revenue (35%) comes from the aftermarket which is higher margin and should be less cyclical (2) the company has a bloated cost structure but has an activist looking over its shoulder. Mark Rachesky (worked for Icahn until starting MHR Partners in the mid 1990s) has accumulated a 14% stake in Titan and was appointed to the board of directors. Rachesky is likely looking to impose better cost discipline on the company. If Titan can bring its operating margins back up to 10% (not a stretch as Titan earned 10% OPM in 2012), the company would earn $2/share. Were the stock to trade at 13x earnings, shares could be worth $26 (+80%). In addition to Rachesky's purchases, another insider (President Paul Reitz) purchased $215,000 worth of shares at the end of July.
Walter Investment (NYSEMKT:WAC) shares have declined 29% thus far in 2014 as investors are concerned about 1) regulatory issues in the mortgaging servicing business which have plagued competitor Ocwen (NYSE:OCN) and 2) a decline in Walter's reverse mortgage business lead Walter to lower 2014 EPS guidance to the lower end of its $5.25-6.25 range. Even if Walter earns just $4/ share, it is selling at only 6x P/E which represents a significant discount to other financials (which trade at 10-14x P/E) and the market as a whole. We believe investors are overlooking: 1) structurally attractive industry whereby 3 players Ocwen, Walter, and Nationstar (NYSE:NSM) control the vast majority of the non-bank, subprime servicing market; this should ensure that bidding for mortgage servicing rights doesn't overheat, allowing Walter to continue to earn ~15% IRRs on the capital it allocates to new MSR purchases, 2) associated potential for continued growth; while Walter may see some falloff in mortgage origination earnings, this is likely to be more than offset by continued growth in the servicing business via MSR acquisition. Assuming that investors were willing to pay just 12x P/E for Walter, we could see shares double. A recent purchase by two insiders is a nice vote of confidence that Walter shares have significant upside.
Though there are sure to be bumps along the way, I believe patient investors will be rewarded with outperformance by aligning themselves with insiders in the aforementioned stocks.
Disclosure: The author is long AVT, WAC, TWI, ARW, OCN, NSM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.