5 Stocks the Bosses Are Buying

As stocks have climbed over the past three months, some top bosses have wasted little time unloading personal stakes in their companies.

In early March, when the S&P 500 index was below 700, about 65% of companies reporting so-called insider transactions were the subject of more buys than sales. By early May, when the index topped 900, that figure had plunged to 38%. It has since rebounded only slightly, to 42%. (I’m using analysis from Form 4 Oracle, a subscription service named for the transaction reports companies must file when top executives, board members or major shareholders buy and sell stock.)

Insider sentiment, and perhaps valuation—the S&P 500 is an ambitious 21 times trailing operating earnings—suggest investors should use caution in putting fresh money into shares. Best, maybe, to favor ones the bosses are still buying. Studies show insiders tend to be successful when they trade their own stocks. Some transactions have more predictive power than others. In general, large purchases, purchases by more than one insider and purchases by “C-level” executives (chief this or that) are worth looking into. Here are examples of each from the past month.

Valeant Pharmaceuticals International (VRX)
Valeant’s stock history is one of much drama but little long-term progress.  Adjusted for splits, shares multiplied 10 times in value over eight years ended spring 1998 (when the company was called ICN Pharmaceuticals) but today trade little above their 1986 peak. Since February 2008, though, the company has had a new chief executive, and has focused on adding products relating to skin disorders (acne, psoriasis, scars) and neurological diseases (epilepsy, Parkinson’s). Sales and profits are growing, debt looks modest and insiders have spent more than $50 million on stock over the past month. The bulk of that comes from an investment firm, but board members and the new boss are buying, too.

Arch Chemical (ARJ)
I suppose Valeant serves as an example of group buying, too, but for another example see Arch Chemical. Based in Norwalk, Conn., it calls itself “the biocide company,” which is sort of like saying “the killer,” only the lives being spent belong to deck fungus, termites, mildew and so on. Part of sales are tied to the struggling home builder industry, and Arch fell from $45 a share in October 2007 to $15 in March, but has since nearly doubled. Three board members bought in May.

GameStop (GME)
Retail in general might be soft, but the nation’s biggest chain devoted solely to videogames is prospering. Sales are expected to climb 9% this fiscal year and profits 18%. Maybe that’s because videogames are low-cost entertainment (versus, say, concerts and theme parks) and because used videogames (whose trade GameStop dominates) carry fatter profit margins than new ones. Whatever the cause, the balance sheet is clean, the return on equity is healthy and all that’s missing is a dividend. The company’s chief financial officer spent just over $1 million on stock over the past week or so.

Of course, there are more important signals to consider than insider buying. Chief among them is valuation. Each of the aforementioned stocks and the two additional ones listed below costs less than the broad market relative to this year’s earnings forecast.