Buy Low with Insiders: 3 Battered Stocks that Appear Poised for a Rebound

Much research suggests that non-insiders can outperform broader market benchmarks by simply piggybacking insider trading behavior. However, one should avoid mimicking every insider purchase or sale, as this blind trading approach might not actually generate the desired trading profits. Individual investors would be better off if they tracked insider trading as part of a broader stock analysis process and didn’t solely rely on insider trading metrics when investing. Another piece of advice investors should take into account is that CEO’s and other top executives tend to have an information advantage over other insiders when trading their companies’ securities. Of course, special blackout windows are put in place to hinder executives and other insiders from violating laws, but their trades can still provide a general idea of how undervalued or overvalued a stock is. As a general rule, insider purchases precede a period of strong stock performance, so let’s take a thorough look at the recent insider buying witnessed at three companies.

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 (read more 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.

The insider buying activity at Rexnord Corp (NYSE:RXN) has been speeding up over the past several months, whereas insider selling has been practically absent since late 2014. Director Paul W. Jones purchased 20,000 shares on Thursday through multiple trades, at prices in the range of $17.09 to $17.15 per share and currently holds a stake of 50,000 shares. The Director also holds 11,003 stock options with an exercise price of $26.37, which the Director will hope to be able to cash in on in the future.

Rexnord Corp (NYSE:RXN) is a growth-oriented industrial company that operates through two business lines: the Process & Motion Control platform and the Water Management platform. The former platform provides gears, gear drives, couplings, industrial bearings, tabletop and engineered chain, aerospace bearings and seals, to name just a few. Meanwhile, the latter platform manufactures products aimed at improving water quality, safety, flow control and conservation. The shares of the company have lost 36% over the past 12-month period, but they are riding a steep uptrend at the moment. Rexnord’s Process & Motion Control segment, which accounts for 56% of net sales, was severely impacted by adverse demand across some of the company’s industrial process end markets. The company’s consolidated net sales for the nine months that ended December 31 totaled $1.43 billion, down from $1.53 billion reported for the same period of the prior year. Rexnord’s diluted income per share from continuing operations reached $0.66 for the first nine months of fiscal year 2016, up from $0.54 per share reported for the same period of fiscal year 2015. It should be mentioned that the stock trades at a relatively cheap forward price-to-earnings multiple of 11.38, while that figure stands at 14.1 for the industrial sector. Charles Paquelet’s Skylands Capital cut its stake in Rexnord Corp (NYSE:RXN) by nearly 69,000 shares during the fourth quarter, to 114,000 shares.

Let’s move on to the next two pages of this article, which reveal the insider purchases registered at Imperva Inc. (NYSE:IMPV) and Lannett Company Inc. (NYSE:LCI).

Imperva Inc. (NYSE:IMPV) had not witnessed any insider buying since late 2012 until this week. Director Albert A. Pimentel reported purchasing 5,000 shares on Monday at prices that ranged from $38.31 to $39.51 per share, all of which are held by the Pimentel Family Trust U/D/T. The family trust fund currently owns 55,000 shares, while the Director holds an additional direct ownership stake of 4,475 shares.

The stock of the cyber-security solutions company has lost more than 52% since December 2015, after having delivered an exceptional performance throughout 2015. Earlier this month, the company released its earnings report for the fourth quarter and full 2015 year. The shares of Imperva plummeted on the announcement, presumably because of worse-than-expected earnings guidance for the 2016 year. The company generated non-GAAP net income of $3.5 million on revenue of $234.3 million in 2015, compared with a non-GAAP net loss of $19.0 million on revenue of $164.0 million reported for 2014. Most importantly, Imperva announced that it anticipates non-GAAP net profit in the range of $5.7 million to $7.7 million for 2016, which does not look overly optimistic given that the company anticipates total revenue in the range of $302 million to $307 million for the year. Similarly, the full-year earnings guidance came in under analysts’ expectations. Indeed, margin expansion is of crucial importance in the long-term, but investors might give it too much importance in the short-term. A total of 23 smart money investors owned the battered stock at the end of the third quarter, amassing nearly 7% of the company’s outstanding shares. Donald Chiboucis’ Columbus Circle Investors boosted its position in Imperva Inc. (NYSE:IMPV) during the last quarter of 2015 to 520,013 shares, up by about 33%.

Lannett Company Inc. (NYSE:LCI) had eight different insiders purchase shares last week, so let’s take a look at the most noteworthy purchases. To begin with, Chief Executive Officer Arthur P. Bedrosian snapped up 4,500 shares last Friday at a cost of $24.91 per share, lifting his overall holding to 618,016 shares. Kevin R. Smith, Vice President of Sales and Marketing, bought 1,500 shares on the same day at $24.75 apiece and currently owns 15,735 shares. Moreover, Director Jeffrey Farber acquired 5,000 shares last week for $24.48 each, enlarging his stake to 2.42 million shares. Vice President of Finance and Chief Financial Officer Martin P. Galvan purchased 3,000 shares at a price of $24.65 per share and now holds a 38,397-share stake. Lastly, 2,500 shares were bought at $24.57 each by Director Albert R. Paonessa III, who currently owns a mere 3,030 shares.

Assuming that exploding insider buying generally precedes a period of market outperformance, one could consider this stock an attractive long-term investment. It should be noted that the shares of Lannett are nearly 58% in the red over the past 12-month period, which fully explains the exploding insider buying. Just recently, Canaccord Genuity cut its price target on the stock to $28 from $46 and maintained its ‘Buy’ rating on it, a move that followed the release of the company’s financial results for the second quarter of fiscal year 2016 that ended December 31. Lannett reported earnings that were in-line with analysts’ expectations, whereas its top-line results missed estimates. However, Lannett appears to be heavily undervalued at the moment, considering its forward P/E multiple of only 5.91, compared to the forward P/E ratio of 15.87 for the S&P 500 Index. Joel Greenblatt’s Gotham Asset Management owned 1.40 million shares of Lannett Company Inc. (NYSE:LCI) at the end of September.

Disclosure: None