Like Cheesecake Factory? These Two Insiders Do

Our database of insider trading filings shows two members of The Cheesecake Factory Incorporated (NASDAQ:CAKE)’s Board of Directors bought shares in the past week. David Pittaway directly purchased 1,000 shares while a trust connected to Herbert Simon bought 20,000 shares; these purchases generally took place between $34 and $35. Studies show that insider purchases are bullish signals, while stocks bought by multiple insiders are particularly likely- though not certain- to outperform the market (read more about studies on consensus insider purchases). This makes sense to us, as economic theory predicts that without a strong opinion of the company insiders should prefer to diversify their investments and so actual purchases- particularly consensus purchases- imply confidence that the stock price will rise. Simon had been making several insider purchases last summer at prices of about $30, and then more at around $33, though Cheesecake Factory has actually underperformed the market since those buys.

Revenue was up 3% in 2012 compared to 2011, as a result of comp sales growth of 2% (in line with comp growth rates in the last two years) and a net addition of locations. Earnings were up 3% for the year as margins remained fairly constant, though EPS grew 9% as The Cheesecake Factory Incorporated used about $100 million of cash to repurchase shares. The company was able to fund these buybacks, a modest dividend (the current yield is 1.4%), and about $90 million in capital expenditures almost entirely through its cash flow from operations. We would note that the fourth quarter results were not good with revenue down slightly versus a year earlier and earnings falling 26%.

At its current market cap of $1.8 billion, the stock trades at 19 times trailing earnings. In the past year most of Cheesecake Factory’s EPS growth has come from reduced share count, and while that has thus far delivered good growth rates we would prefer to see better growth of net income (in addition, the most recent quarter’s performance is certainly worth questioning). Wall Street analyst consensus implies a forward P/E of 14. A number of market players are bearish on the stock judging by the fact that 15% of outstanding shares are held short.

The Cheesecake Factory Incorporated does not have much of a following among hedge funds and other notable investors that we track in our database of 13F filings. This is somewhat significant to us since small-cap stocks such as this can be particularly rich sources of alpha for hedge funds if they are undervalued. We have actually found that the most popular small cap stocks generate an excess return of 18 percentage points per year on average (learn more about our small cap strategy). The largest position in Cheesecake Factory among the filers we track belonged to billionaire Mario Gabelli’s GAMCO Investors, which reported a position of 1.1 million shares (see Gabelli’s stock picks).

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