Jonathan Moreland

So You Think Bank Stocks Have Bottomed?

Insider buying patterns may offer clues (and traps).

August 18, 2008
by Jonathan Moreland

[DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.]

I would say, "there they go again," but the fact is that executives and directors at banks and other related financial institutions have been buyers of their firms' shares for the past year.

That's right, the sector whose problems have been largely responsible for the overall decline in the stock market and the health of the U.S. economy has also been one of the most heavily insider-bought sectors throughout the mortgage-cum-credit crisis.

But this overwhelmingly bullish sector call by insiders was extremely easy to dismiss — at least by my way of using insider data. Having analyzed the legal insider data filed at the SEC (Securities and Exchange Commission) for the better part of two decades, this information flow is an extremely important part of my process for finding new investment ideas. In fact, it's my very first screen. But even so — and even for me — it is only part of the process.

As CPA Insider™ readers familiar with this column know, many bank stocks may have made it through my initial insider screens for determining significance over the past year. But when I've applied the fundamental and technical parts of my process to these potential long ideas, they have generally failed to make the cut.

I have nibbled on a couple names over the past year in order to keep my interest sharp in the sector. After all, there's nothing like owning a stock to keep your attention on it and its sector. But even the seemingly higher quality name or two I've owned was affected by the immense pall that has hung over the group. And with each new shoe that drops, and each new technical resistance that has held, my conclusion to not invest heavily in this group in the near term has been confirmed.

So are financial insiders as dense about their stocks' attractiveness as they seem to be about the value of the assets in which they are generating and/or investing? Sure, academic studies — and my own experience — have confirmed that insiders tend to be early with their investment calls. But when does "early" become just plain "wrong?" That depends upon you're investment time frame, and there is a very useful precedent to consider before investors totally dismiss banks (and bank insiders) as dismal failures.

Brief History

In early 1997, the price for a barrel of oil fell below $20, and the stocks of energy E&P (Earnings & Profits) firms fell in concert. Energy insiders bought into the decline almost immediately, signaling their bullishness. Unfortunately for these "early birds," the price of oil continued to decline. To $18; then $15; then $12. And finally, in December 1998, nearly two years later, to $10.

All through that time, the E&P stocks were getting crushed, and insiders continued to buy in. Articles in the financial press openly called energy insiders "clueless" for buying their shares over a year and a half earlier at much higher prices.

Well, the financial crisis is only just over a year old, and insiders at banks now appear to be similarly clueless. But within a couple years of being openly insulted in the press, oil was right back up to $25 a barrel, and even those clueless insiders who bought early in 1997 were sitting on fabulous capital gains.

I think several years' worth of hindsight will prove insiders at financial institutions to have been just as early, but — in the end — just as right as those energy insiders in the late '90s.

That doesn't mean I'm ready to jump wholesale into bank stocks yet. I still have too great a suspicion that there is yet another shoe to drop on the financials. My bias towards expecting slower economic growth and higher interest rates over the coming year also makes me reticent to call a bottom in the group.

But, I could well be wrong. And for those of you whose clients feel inclined to buy into the recent strength of bank stocks, I offer you a table of choices where insiders have also recently done the same. You can bank on that.

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Jonathan Moreland is the Director of Research at New York-based InsiderInsights.com. View a FREE trial issue of the firm's weekly newsletter InsiderInsights.