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  Look carefully at insider, buyback stats

BENJ GALLANDER and BEN STADELMANN

Friday, March 18, 2005

Trends in corporate buybacks, insider selling and equity financings are not always what they seem to be.

For instance, what are we to make of the record $48.7 billion raised in 2004 by Canadian corporations? The figure's not as imposing as it might appear, since a lot of this is not new money: about a third of the total is the result of conversions to investment trusts.

As many of these were already publicly traded companies, this putting of old wine into new bottles exaggerates the amount of new money raised. Whatever the merits of individual trusts, and they vary widely, the cornerstone of this sector's tremendous growth is that these business entities pay little tax.

On another front, the ratio of insider selling to insider buying reached epic proportions recently. If those who should know most about business prospects are dumping their shares, shouldn't those on the "outside" follow their lead? Academic studies have shown the efficacy of insider buying as a positive buy signal, and our own experience bears it out.

The granting of options and restricted stock has become so prevalent that executives have less need to purchase stock in the open market in order to "have some skin" in their company's fortunes. Meanwhile, as these awards make up a large portion of their personal worth, selling can be a simple matter of financial diversification.

Another statistic that is in record territory is the value of stock buybacks by corporations. Generally, these purchases can be seen as bullish, as they essentially return money to shareholders via an indirect route. With a declining share count, metrics such as book value and earnings per share improve.

But this historical pattern needs to be understood within the context of how executive compensation packages have changed. In effect, the phenomena of extraordinary levels of corporate buybacks and insider selling can be seen as two components of the same trend. Companies create new shares for management, causing dilution, then the corporation buys stock back to mitigate that dilution.

Take personal computer maker Dell, for example. The company recently announced that an additional $10 billion (U.S.) had been authorized for the company's stock buyback war chest. Chief financial officer James Schneider called share repurchases "a priority use of our cash." That sounds like a big vote of confidence from management.

Now bring up the insider-trading stats. For the past year, total insider sales were 37.5 million shares for proceeds of $1.39 billion. Total shares purchased: a big fat zero. Which is not to pick on Dell; many other favourites such as Intel, Apple, Amazon and Cisco all exhibit the pattern of generous stock grants, massive insider selling, and billions of dollars in buybacks.

Sir John Templeton is credited with the adage that the four most dangerous words for investors are "it's different this time." That advice was borne out when the foundation of the "new economy" of the 1990s was shown to be smoke and mirrors.

Investors would also be wise to consider Mark Twain's warning: "History doesn't repeat itself, at best it sometimes rhymes."

As the landscape of the stock market is sculpted by a variety of forces — some traditional, but others novel — investors need to scrutinize statistics that sound impressive.


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