Leading Indicators for Investors: Corporate spinoffs, share buybacks, insider buying and stock splits can all signal what insiders think lies ahead for their company’s share price

September 6, 2013, 6:17 p.m. ET

Leading Indicators for Investors

Corporate spinoffs, share buybacks, insider buying and stock splits can all signal what insiders think lies ahead for their company’s share price.



With the economy recovering and markets on a tear, American corporations are snapping into action—spinning off subsidiaries, buying back stock and making other moves that are widely viewed as telling signals of how insiders value their own firms. A recent flurry of high-profile activity raises a question for investors about how to interpret those signals: Buy or beware? In addition to spinoffs and buybacks, the moves in question include insider share purchases and stock splits. Apple,AAPL +0.60% Valero Energy and Whole Foods Market WFM +0.61% are among the big U.S. companies that have made or announced such moves this year. (Among the companies that did a spinoff this year is News Corp NWSA -0.31% ., which split into a media and entertainment company named 21st Century Fox FOXA +0.47% and a publishing business called News Corp, which is the parent of Wall Street Journal publisher Dow Jones & Co.)Typically, these maneuvers have little or nothing to do with the nuts-and-bolts operation of a business. Instead, many investors consider them a sign that people who know the company best think the market isn’t giving it full credit—and that the company’s share price therefore is too low.

“What boards do with resources matters,” says Rob Lutts, president of Cabot Money Management in Salem, Mass., which manages over $500 million and invests in funds that track spinoffs and buybacks.

Investors are backed in this belief by evidence that shares of companies affected by these kinds of moves often outperform peers for months, and in some cases even years, to come.

This year has brought fresh support for the strategy. Apple shares have risen 23% since the consumer electronics giant announced in April that it would spend another $50 billion buying back its shares. The S&P 500 has gained 4.8% over the same period.

Meanwhile, the Guggenheim Spin-Off CSD +0.21% exchange-traded fund—which buys shares in companies starting six months after they were spun off, and holds them for up to two years—has climbed 31% this year, topping the 21% gain in the Russell 2000, an index of smaller companies that includes some of the fund’s holdings.

But investors who have caught sight of the recent announcements and disclosures should tread carefully. Even those who invest in such companies warn that the strategy doesn’t pay off in many cases.

Investors can’t know all the considerations and motives that executives are weighing when they act, so the risk of misinterpreting a signal is high, they warn.

Moreover, other factors tied to a company’s bread-and-butter business likely have a larger influence on share prices.

As a result, investors drawn to the strategy need to examine a firm’s finances and prospects more closely. The moves are akin to clues, says David Merkel, who runs Aleph Investments, a registered investment adviser in Ellicott City, Md., that manages $7 million.

“Not every clue gives you the full answer about something,” says Mr. Merkel, whose holdings include recent spinoffs.

Investors can try to limit the risk by investing in an array of affected companies. In addition to the Guggenheim ETF—which charges annual fees of 0.65%, or $65 on a $10,000 investment—there are other exchange-traded funds that focus on firms that have bought back shares or firms where corporate insiders have been buying shares.

Yet a broader portfolio of similar companies only offers so much protection. The concept of investing based on spinoffs, buybacks, insider buying or stock splits is widely known, so bargains may be harder to come by.

“Maybe the markets have learned” that investing in these companies can pay off, says Hemang Desai, a professor of accounting at Southern Methodist University who has written about both spinoffs and stock splits. “Maybe the hedge funds have learned.”

Another factor to consider: the cost to corporate insiders if the supposedly bullish signal is false, says John McConnell, a finance professor at Purdue University who co-authored a 2004 study of spinoff performance.

If there is no cost, he says, “the signal doesn’t mean much.”

For example, deciding to split a company’s stock can come with little or no consequence for directors and executives, Mr. McConnell says. But committing to spend company cash to buy back shares, rather than investing it in the business, can be “a bit more of a credible signal.”

The signals also differ in other important ways. Here are things investors need to know about how to read each one:


When a parent company cuts loose one of its units, an onlooker might be inclined to pity the orphan. For investors who place their bets well, though, the newcomer can often perform more like a golden child.

Researchers have found over the years that stocks of spun-off companies often slump in the initial days of trading.

They offer many explanations. Investors and funds that own the parent company’s shares might sell the spinoff because the new company may not fit in the investor’s portfolio or isn’t part of the index the fund tracks, Credit Suisse said in a report last year. Some investors might want to see how the fledgling fares on its own for a while. ‪

‘The belief is that the value is not being recognized.’”

But the kid often bounces back over the weeks and months that follow.

The typical spinoff whose parent is in the S&P 500 underperformed the index by 2.4 percentage points over the first month, but outperformed the index by 5.6 points over three months and 17.4 points over 12, according to an analysis by Nasdaq OMX Group’s corporate solutions unit of spinoffs since March 2009, when the stock market was near its financial-crisis low.

Fans say the turnaround shows that subsidiaries are frequently misunderstood when they first emerge from the parental shadow.

“The belief is that the value is not being recognized in the marketplace,” says Mr. Lutts of Cabot Money Management. The firm has about 2% to 5% of assets in the Guggenheim Spin-Off ETF in some client portfolios, he says.

Some spinoffs thrive. About a year ago, Nacco Industries NC +0.57% spun off a unit called Hyster-Yale Materials HandlingHY -0.79% a forklift maker based in Cleveland. Since trading began on Oct. 1, shares in the new firm have climbed 88%, compared with a 22% rise in the Russell 2000.

But others falter—and sometimes the entire strategy can go south. In 2008, for example, when the S&P 500 dropped 38% and the Russell 2000 fell 35%, the Guggenheim Spin-Off ETF plummeted 57%.

Mr. Desai, of Southern Methodist University, says the boost to returns typically comes when the new company does something fundamentally different from the parent. Management can fully focus on what is now the main business.

Bill Mitchell, who runs a monthly newsletter that analyzes spinoffs, tries to find the ones that are undervalued. “Many spinoffs are a bad deal,” he wrote in an email. “Spinoffs are merely a good universe, a place to look for bargains.”

Share Buybacks

Few company announcements are more beloved by investors than those that indicate a share buyback is in the offing.

In a buyback, a company uses cash or raises debt to purchase its own shares, often as an alternative to paying dividends or distributing excess cash. All else being equal, that should reduce the number of shares outstanding and, in turn, raise the value of the ones that remain.

David Ikenberry of the University of Colorado Boulder found that companies announcing share repurchases had a total return after four years that was 12 percentage points higher on average than the overall market, after adjusting for stock size and style.

Sometimes investors take the announcement of a buyback as evidence that executives think the company is underpriced, he says.

Companies don’t always follow through on actual purchases. If the stock price rises in the interim, repurchasing stock can become a poor use of a company’s cash, Mr. Ikenberry says.

But buyback announcements don’t always lead to price increases. In July 2012, AT&T said it would buy back as many as 300 million shares, or as much as $11.1 billion worth of stock.

Though the share price got an immediate boost following the announcement, since then shares have faltered, dropping 5.5%, including dividends, even though AT&T completed the share buyback and has approved new buybacks since then.

With individual stocks, Mr. Ikenberry found that the best returns occurred in companies that announced buybacks and had a low price/book ratio, calculated by dividing the company’s share price by its per-share net asset value.

Last month, companies announcing buybacks included food company Mondelez InternationalMDLZ +0.65% medical-lab operator Quest Diagnostics DGX +0.99%and mining-equipment maker Joy GlobalJOY +0.28% according to research firm Dealogic, each of which had price/book ratios lower than that of the S&P 500, according to FactSet. Quest’s and Joy Global’s stock prices have risen since their announcements, but the share price of Mondelez has fallen.

A more diversified investment in the buyback phenomenon is the PowerShares Buyback Achievers PKW -0.24% ETF, which invests in companies that have repurchased 5% or more of their shares in the past year, which has an annual expense ratio of 0.71%. The fund is up 28%, including dividends, in 2013, beating the S&P 500 and the Russell 2000.

Although a buyback should reduce the number of shares, in practice, sometimes they simply offset shares created as part of executive compensation. Some investors try to weed such companies out by only picking companies whose share count is actually falling.

For example, the AdvisorShares TrimTabs Float Shrink TTFS +0.09% ETF, which costs 0.99% annually, homes in on companies whose buybacks aren’t undone by share creation elsewhere. The fund is up 27% this year, including dividends.

Insider Purchases

Who better to decide whether a stock is a “buy” or a “sell” than the board members and executives who know the company best?

That is the theory behind following legal trading by so-called insiders, who must disclose purchases and sales to the Securities and Exchange Commission, which can be found at www.sec.gov.

University of Michigan finance professor H. Nejat Seyhun pinpointed the months between 1975 and 1994 when company executives were net buyers of their company’s stock and the months when they were net sellers. He measured the stocks’ performance for the ensuing 12 months.

After a month of net insider buying, he found that company shares had a total return of 24% over the following year, on average. After sell months, they had a total return of 15%. The 12-month return for a typical stock in those years was 19%.

Not all insiders know the company equally well, Mr. Seyhun says.

For example, investors who aren’t executives but own a large percentage of a company are considered “insiders” but typically aren’t good predictors of where a firm’s share price is headed, he says.

After stripping out such investors, Mr. Seyhun’s research finds that insider sentiment can give a good estimate of future returns for the overall market.

The message isn’t particularly good or bad. July’s level of net insider buying is the lowest it has been since early 2011, suggesting that the broad stock market will return about 4.2% over the next 12 months, which is less than average, Mr. Seyhun says.

Insider selling also can be helpful in interpreting what to make of other corporate actions, says University of Kentucky finance professor Alice Bonaimé.

For example, the positive impact on stock prices from buybacks is partially negated if company insiders are selling at the same time, according to research by Ms. Bonaimé and Michael Ryngaert of the University of Florida published this month.

In the three years after a buyback announcement, companies with net insider buying had an extra total return of 16.9 percentage points, after adjusting for size and value, while companies with net insider selling had an extra return of only 1.2 percentage points, the research found.

“The knee-jerk reaction to a firm that announces a repurchase is to say ‘Let’s go out and buy their stock,'” Ms. Bonaimé says. “You have to look at what insiders are doing at the same time.”

The Guggenheim Insider Sentiment NFO -0.07% ETF, which costs 0.65% annually, tracks an index that includes stocks with positive insider buying trends. The fund has gained more than 20% in 2013, including dividends.

Stock Splits

Of all the signals insiders can send, stock splits seem like the faintest—and the easiest to misread. When a company gives shareholders two shares in exchange for one, for example, the number of shares outstanding doubles and each is worth half as much. No unit gets a chance to shine on its own. No money changes hands.

Still, some researchers, including Mr. Ikenberry, have found that shares on average outperform for years after a split.

The explanation? Splits seem to be a sign of confidence, Mr. Ikenberry says. Executives wouldn’t halve the per-share price if they thought the stock would soon fall for other reasons, he says.

Yet stock splits might have limited value as an insider signal for another reason—companies are doing them less often. In the middle of the last decade, there were more than 200 splits a year by companies traded on major U.S. exchanges, according to S&P Capital IQ. This year, the total is on pace to end up closer to 70, a significant drop (though higher than the 20 in 2009, amid the crisis).

It could be that the rise of ETFs in recent years means that companies worry less about high per-share prices deterring individual investors, says Richard Peterson, a director at S&P Capital IQ.

Another possible explanation, he says: Directors might be worried they could face legal challenges for taking any kind of corporate action without a clear justification.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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