Editor's note: If you haven't yet watched Whitney's brand-new presentation on how to take advantage of one of the most reliable indicators in investing – following the insiders into trades – you can watch it, for free, right here.
Over the past few days, I've revealed how insider buying works as a reliable trading indicator during any market, up or down...
Remember, insiders can be company executives in positions of oversight (such as CEOs, CFOs, directors, etc.) or beneficial shareholders (investors who own 10% or more of the stock) who have intimate knowledge of their companies.
And as I've explained more than once, insider buying tends to precede a higher share price because these well-informed individuals only buy their stock if they believe it's going up.
It really is that simple. Insiders sell for many reasons, but they only buy if they think they'll make a profit.
But there's another lesser-known aspect to insider buying that I haven't discussed yet...
I'm talking about share buybacks, which are sort of a "backdoor" to insider buying.
Rather than an individual going out and buying shares, the company can elect to repurchase its own shares from the open market.
Think of it like a pizza... When a company lowers its share count, it's like cutting a pizza into fewer slices. The size of the pizza stays the same, but your slice gets bigger.
Done right, buyback programs can one of the most powerful things companies can do with their cash, yet it's also the most controversial because companies often do it all wrong.
The key is for a company to only buy back shares when they're trading at a meaningful discount to intrinsic value. Buying dollar bills for less than a dollar – ideally for $0.80 (or less) – creates value.
The ideal is when a business regularly repurchases its shares and grows its intrinsic value meaningfully over time. The key is that the company needs a good grasp of both its current intrinsic value and its future growth prospects.
Repurchases can be really powerful... If a company buys 2.8% of its outstanding shares every year, it can reduce its share count by a quarter over a 10-year period. At 6.7% annually, the share count will drop by half in a decade. In this case, even if earnings are flat, earnings per share will double!
Consider the following examples of well-timed share repurchases...
Over the past five years, Starbucks (SBUX) has lowered its share count by 20%, while its stock has nearly doubled.
Over the past decade, Apple (AAPL) has lowered its share count by 40%, while its stock has gone up more than 1,000%.
And the most remarkable example I've ever seen is auto parts retailer AutoZone (AZO).
In the two-plus decades since hedge-fund manager Eddie Lampert invested in the company in 1999 and pushed for big share repurchases, it's been buying back an average of 8.5% of its shares every year.
This has caused the share count to decline by a stunning 87%. Thus, in a period when earnings rose a healthy six times, earnings per share skyrocketed 34 times – and, not surprisingly, so did the stock...
Sadly, AutoZone is the exception, not the rule – and buybacks aren't always a good thing...
Most companies destroy value by buying back shares aggressively when they're overvalued and not at all when they're cheap.
When times are good, in order to "show confidence in the stock" or juice earnings, they take $1 of their cash and buy shares that are worth less than $1, which of course destroys value.
Then, during turbulent times when the stock has fallen, they get worried and cease repurchases.
If a company's stock is fully valued (or overvalued), then shareholders would be better off receiving excess cash via a dividend. At least then they're getting a dollar of value for each dollar of cash.
Journalist Jason Zweig highlighted three of the worst offenders in a recent column for the Wall Street Journal. As he wrote...
Lehman Brothers spent $2.6 billion buying back its own stock in 2007, and in the first two fiscal quarters of 2008 it shelled out nearly $1.5 billion more. Less than six months later the Wall Street behemoth went bust.
As the Wall Street Journal snidely pointed out in 2009, Citigroup (C) repurchased more than $20 billion in shares from 2004 through 2008 – right before it needed a roughly $45 billion government bailout during the financial crisis.
Zweig also noted that since December 2004, retailer Bed Bath & Beyond (BBBY) spent nearly $12 billion buying back 265 million shares.
He pointed out that during the meme-stock craze of 2021, Bed Bath & Beyond management paid more than $26 for some of those shares... Today, they trade for well under a buck, and the company – having just filed for bankruptcy – sports a market cap of only $50 million!
For these reasons, we look for companies that have a history of buying back their own stock when it's cheap...
We also look for situations where management has a longstanding connection to the business and plenty of "skin in the game." After all, if a company's founder owns $100 million shares, he has 100 million reasons to want the stock to go up as much as you!
Furthermore, management teams who own plenty of their own stock are financially motivated to execute buybacks at the right time.
A perfect example of trustworthy insiders comes from department-store chain Dillard's (DDS)...
Founded by William T. Dillard 85 years ago as a small department store in the sleepy farming town of Nashville, Arkansas, Dillard's has grown to 250 locations across 29 states.
It's also one of the greatest stocks of all time, up more than 17,000% since going public in 1983, generating annual returns of about 14%.
Dillard's insiders have a ton of skin in the game, owning about 30% of the stock, and the company is still run by its founders.
In February 2022, longtime Director Warren Stephens made the biggest insider purchase at the company since late 2008, buying 20,000 shares with the stock at $227.
DDS shares – and Stephens' $4.5 million investment – rose more than 80% less than a year later...
Investors who noticed Stephens' huge sign of confidence in Dillard's business would have been well rewarded.
And now, you can follow the insiders...
To learn how to take advantage of these "whispers" and follow insiders into what could be some of the biggest, most profitable trades of Empire Financial Research's history... watch my free presentation right here.
Best regards,
Whitney Tilson
April 27, 2023
