According to a filing with the SEC, VCSC Investments LLC- which is connected to the CEO and President of Dresser-Rand Group Inc. (NYSE:DRC), Vincent Volpe Jr.- purchased almost 18,000 shares of the company’s stock on March 8th at an average price of $57.02 per share. Studies show that socks bought by insiders narrowly outperform the S&P 500 (read more about studies on insider trading) and we think that this is because insiders are economically incentivized to avoid becoming too exposed to the company-specific risk inherent in both being employed by a company and owning its stock unless they are particularly confident that the stock price will rise.
Dresser-Rand Group Inc. is a $4.4 billion market cap provider of equipment and parts to energy, industrial, and power generation customers. Last quarter the company’s revenue increased 14% from its levels in the fourth quarter of 2011, and although this was a little bit lower than its top line growth earlier in 2012 it was still a solid performance. Earnings growth also decelerated but was still in double digits at 16%.
With a trailing earnings multiple of 25, more growth is currently priced into Dresser-Rand’s stock though it’s possible that if the company can sustain current growth rates it would still turn out to be undervalued. Wall Street analysts are expecting the next several years to be very strong: the forward P/E is only 13 and the five-year PEG ratio is 0.5. So the CEO is agreeing with the sell-side that earnings growth will be high- in fact, it appears that both parties are expecting earnings growth to be somewhat higher than the Q4 results. Of course Dresser-Rand Group Inc. did record higher growth rates in the first nine months of 2012 than in this most recent quarter, so this is not an unreasonable forecast, but we generally expect growth rates to slow over time.
Adage Capital Management, which is managed by Phil Gross and Robert Atchinson, initiated a position of over 1 million shares in Dresser-Rand in the fourth quarter of 2012 (see Adage’s stock picks). Iridian Asset Management was the largest holder of the stock in our database of 13F filers, reporting ownership of 3.8 million shares (find Iridian’s favorite stocks). We’d call hedge fund participation in the stock moderate. We think that it’s important to see how hedge funds and other notable investors are trading these small cap stocks because as they are less closely studied they can often be sources of alpha. In fact, we have found that the most popular small cap stocks among hedge funds produce an average excess return of 18 percentage points per year (learn more about our small cap strategy).
We would compare Dresser-Rand to Siemens AG (NYSE:SI), General Electric Company (NYSE:GE), ABB Ltd (NYSE:ABB), and Flowserve Corporation (NYSE:FLS). These four companies trade in a narrow range in terms of their trailing earnings, with P/E multiples between 17 and 19. This represents a considerable discount to Dresser-Rand on that basis. However, most of these companies are considerably larger and so do not have as strong growth prospects; in fact, last quarter both Siemens and ABB experienced a decline in net income compared to the same period in 2011. Analysts expect high growth rates at these four companies as well, but lower than at Dresser-Rand with the result being that they all carry forward P/Es between 11 and 14. As such it’s possible that that company’s superior potential is already accounted for in the stock price and the five stocks are priced relatively fairly.
It’s always notable when a company’s CEO is buying shares, even if it is through an LLC, and we do like Dresser-Rand’s growth rates. However, the trend in revenue and earnings growth appears to be down and yet the current price assumes a large amount of improvement in the next few years in order to compensate for the premium to similar companies in terms of trailing earnings. As a result we would be cautious about buying the stock and would certainly need to ease our concerns about the falling growth rates before buying any shares.
Disclosure: I own no shares of any stocks mentioned in this article.
