Buy Beaten-Down Stocks With Insiders: Three Stocks to Buy at Deep Discounts

All major U.S stock indexes closed sharply in the green on Monday, which might suggest that equities are set to continue their bull course at least through the end of the year. The Dow Jones Industrial Average gained 165.22 points in the first trading session of November, and has advanced by more than 9% since the beginning of the fourth quarter. In the meantime, some companies’ insiders have also regained confidence in the stock market and started piling up more shares of their companies. Generally, insider buying is relatively straightforward to interpret: insider buys represent signs of potential future stock price appreciation. Even so, this type of activity should be closely examined and accurately interpreted prior to making any moves, as insiders may also make the wrong judgement in some instances. Thus, let’s proceed with the discussion of the insider buying activity at three U.S-listed companies.

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Most investors can’t outperform the stock market by individually picking stocks because stock returns aren’t evenly distributed. A randomly picked stock has only a 35%-to-45% chance (depending on the investment horizon) to outperform the market. There are a few exceptions, one of which is when it comes to purchases made by corporate insiders. Academic research has shown that certain insider purchases historically outperformed the market by an average of seven percentage points per year. This effect is more pronounced in small-cap stocks. Another exception is the small-cap stock picks of hedge funds. Our research has shown that the 15 most popular small-cap stocks among hedge funds outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward testing the performance of these stock picks since the end of August 2012 and they have returned 102% over the ensuing 37 months, outperforming the S&P 500 Index by more than 53 percentage points (read the details here). The trick is focusing only on the best small-cap stock picks of funds, not their large-cap stock picks which are extensively covered by analysts and followed by almost everybody.

Let’s kick off our discussion by looking into the insider trading activity at furniture and electronics rent-to-own company Rent-A-Center Inc. (NASDAQ:RCII). Chief Executive Officer Robert Dale Davis snapped up a 10,000-share block on Friday at a price of $18.42 per share. After the recent transaction, the CEO currently holds a stake of 75,595 shares. Meanwhile, Director Jeffery M. Jackson purchased 1,200 shares on Thursday at a price of $17.76 apiece, enlarging his holdings to 2,700 shares. The shares of Rent-A-Center Inc. (NASDAQ:RCII) are down by 49% year-to-date, partially due to its disappointing third quarter earnings report. Just a few days ago, KeyBanc Capital Markets downgraded the stock to ‘Sector Weight’ from ‘Overweight’, citing the company’s disappointing performance in the third quarter. Even so, the stock is currently trading at a trailing P/E ratio of only 9.74, compared to the ratio of 22.65 for the S&P 500. Hence, the aforementioned insiders may be buying shares on weakness. Hirzel Capital Management, founded by Zac Hirzel, held its stake in Rent-A-Center Inc. (NASDAQ:RCII) unchanged during the second quarter at 2.07 million shares.

The next page of the article discloses the insider buying activity at two struggling companies.