Insider buys indicate what may pay off

John Dorfman
| Tuesday, Sept. 13, 2011

Here are the latest dispatches from the insider-trading front.

We are talking about legal insider trading here. The officers, directors and major shareholders of public corporations have to report their trades to the Securities and Exchange Commission within two days. Those reports show recent buying at Morgan Stanley (MS), Emerson Electric Co. (EMR) and Merck & Co. (MRK).

At Morgan Stanley, insiders have purchased about $3.7 million of stock in the past three months. CEO James Gorman bought more than half of it. He picked up 100,000 shares on the open market, bringing his holding to more than 900,000 shares.

Gorman paid $20.62 a share for his latest purchase, and the stock is at less than $16 a share now, following a market decline that chewed up financial stocks in August.

I consider Morgan Stanley, which is based in New York City, the second-largest U.S. brokerage house (after Goldman Sachs). Technically it is now a commercial bank, but I consider that a fig leaf -- a ploy that helped both Morgan Stanley and Goldman Sachs get aid during the financial crisis.

Having been badly burned in Bear Stearns shares three years ago, I am wary of the big debt loads carried by most brokerage houses. Morgan Stanley, for example, has about $10 in debt for every dollar of stockholders' equity.

Nevertheless, I think Gorman's purchase, and that of two colleagues who also bought in August (plus a director who bought in early September), will pay off. The stock is selling for only 0.5 times book value, or corporate net worth per share.

Over the past 10 years, Morgan Stanley shares have usually sold for about 1.5 times book value, or triple today's ratio. In general, I advise investors to buy brokerage house shares when, and only when, they are selling below book. Now is the time.

At Emerson Electric in St. Louis, five insiders bought about $2.3 million of stock in the past three months. One of them was August Busch III of the Anheuser-Busch family, who is an Emerson director.

Emerson is a manufacturer that dates to 1890, but it is unusually successful, diversified and international. In fiscal 2010, it had about $21 billion in sales, of which a little over $10 billion was in the United States, about $4 billion in Europe, $4 billion in Asia and the rest in other places. It has more than 250 manufacturing facilities worldwide.

Emerson came through the recession of 2007-2009 much better than most manufacturers. It has posted a profit at least 24 years in a row (as far back as my database goes).

At Merck, two top officers have bought shares recently. CEO Peter Kellogg bought 15,800 shares in August at prices just below $32. That's also where the stock was as of Sept. 9. Kellogg now owns about 54,000 shares, worth roughly $1.7 million.

Merck's chief financial officer, Kenneth Frazier, picked up more than 32,030 shares in August. He owns 195,506 shares, worth about $6.2 million.

Investors should always take note when there's a marked change in the pattern of insider buying. In the case of Merck, there has been no significant buying for the past decade -- until last month.

Here is a quick follow-up on stocks highlighted in this column a year ago because they had significant insider buying.

Monsanto Co. (MON), which I said was suitable for growth investors, rose 25 percent in the 12 months following my Sept. 7, 2010, column. Lately, there have been more insider sales than purchases.

EMC Corp. (EMC), which I said was fairly priced, was up 12 percent. Insider actions lately have been sales.

CME Group Inc. (CME), which I said "looks like a reasonable purchase," gained 5 percent. At this company, parent to the Chicago Mercantile Exchange, insiders have been quiet lately, with more sells than buys.

Legg Mason Inc. (LM), which I recommended, edged up 0.5 percent. Trian Partners, a major shareholder, continues to accumulate the stock.

Akamai Technologies Inc. (AKAM), which I said was too expensive, fell 57 percent. This technology stock, which hit $327 a share in 1999, now sells for about $21. Most recent insider transactions have been sales, but Tom Leighton, chief scientist, bought 50,000 shares in May.

I think Akamai shares would be a buy if they fall just a few more points -- say to $17 or less.

As a general rule, insider buying is more predictive than insider selling. There are many reasons to sell -- a home purchase, a divorce, and so on. There is only one reason to buy. Studies have indicated that purchases by the chief executive officer or chief financial officer have higher predictive value than purchases by other insiders.

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