Watch Where The Money Goes

Disclaimer: I am not a licensed investment advisor, I blog about my understanding about the financial markets. This article is written with the assumption that the readers understand fundamental analysis. 

“There are many possible reasons to sell a stock, but only one reason to buy.”

To gain an edge as investors, we need to understand fundamental analysis with a keen interest of what the insiders are doing with their money.

Sometimes, it is the simplest detail that reveals everything.

Watch how money flows in and out of the company.

Do not read what the management is saying, but watch where their money goes.

There have been so many occasions where I was extremely tempted to purchase a company however the management’s actions are flashing red lights to me. I dropped those companies immediately.

On the other hand, there are some companies that I am still keen on even after they went up 10 times in share price because the management, especially the financial officer, did not sell a single share.

This kind of inaction tells me the management believes the future is still going to be bright.

When I invest, I am partnering with the management. I need to be able to trust and decipher what he/she is thinking. Access to management is also very important to me.

Whenever the management is telling me their business is going to recover well, but they do not buy back their shares, I tend to be more skeptical of their words.

The opposite is also the case. There are many times where I see many investors buy a company just because the management is purchasing their share. 

That’s dangerous.

What you want, is to be be very careful by studying the historical buying/selling patterns of management. Have they been right most of the time? Or wrong all the time?

They understand their own company’s valuations the best.

Example #1 – Starhub

Starhub is a SGX-listed telecommunication company.

(Share Price of Starhub extracted as of 12/04/2019)

In November 2016 period, Starhub purchased back their own shares. Despite that, the share price continued to spiral down.

Two months ago, Starhub purchased their shares again. For investors, they may pick it up as a buying signal as it may mean that Starhub is undervalued.

However… if investors bothered to do their homework, they would observe that the management have not been right about their purchase in the previous round (November 2016).

Secondly, on 17 November 2017, Starhub announced CEO Tan Tong Hai to step down on 1 May 2018.

11 days later, on 28 November 2017, then-CEO Tan Tong Hai sold 42% of his original holdings at $2.84. Few months later, the share price fell more than 40%.

The track record of Starhub buying back their own shares and the sale of shares by then-CEO Tan Tong Hai does not inspire any form of confidence.

By studying the historical buying/selling patterns, you’ll realise have they been right or wrong.

Example #2 – SmartGroup

SmartGroup is an ASX-listed company and there were a series of transactions which left me puzzled. Firstly, let us take a look at the share chart:

On 18 February 2018, SmartGroup released a set of results that was underwhelming.

The share price continued to drop until 29 March 2019.

Then, what happened on 1st April 2019? Smartgroup declared a special dividend of 20 cts. As a result, the share price shot up by 3.66%.

Confusingly, the next day, the CEO Devendra Billimoria sold 27% of his shareholdings in one trade.

This means he won’t receiving the special dividends.

He sold his shares ONE DAY after the company declaring the special dividends.

Did he time his own sale together after the special dividend announcement? Is it pre-planned so that he can sell it at a higher price? The special dividend announcement created demand for the shares.

Subsequently, one of the executive directors (Gavin Bell) invested roughly AUD $20.6k to increase his shareholdings in the company. This opposite of what CEO Devendra did.

To be honest, I do not know why CEO Devendra decided to sell his shares. Priced roughly at AUD $8, it looked reasonably valued… however, when CEO Devendra decided to sell 27% of his shares, I changed my view for the worst.

Example #3 – STAMPS.com

First Quarter 2018 Financial Highlights (announced 3 May 2018)

• Total revenue was $133.6 million, up 27% compared to $105.0 million in the first quarter of 2017.
• GAAP net income was $47.0 million, up 42% compared to $33.1 million in the first quarter of 2017.

Second Quarter 2018 Financial Highlights (announced 1 August 2018)

• Total revenue was $139.6 million, up 20% compared to $116.1 million in the second quarter of 2017.
• GAAP net income was $45.5 million, up 47% compared to $31.0 million in the second quarter of 2017.

Third Quarter 2018 Financial Highlights (announced 31 October 2018)

• Total revenue was $143.5 million, up 25% compared to $115.1 million in the third quarter of 2017.
• GAAP net income was $33.4 million, down 28% compared to $46.2 million in the third quarter of 2017.

Fourth Quarter 2018 Financial Highlights (21 February 2019)

• Total revenue was $170.2 million, up 29% compared to $132.5 million in the fourth quarter of 2017.
• GAAP net income was $42.7 million, up 6% compared to $40.2 million in the fourth quarter of 2017.

Red denotes an insider sale.

Green denotes an insider purchase.

Using OpenInsider, we can see the management were selling the shares so aggressively in 2018. Then, in the next year, something happened.

According to Bloomberg,

“Stamps.com Inc. investors had a rude awakening as the company said it would end its exclusive partnership with the U.S. Postal Service, and highlighted increasing threat from Amazon.com Inc’s aggressive moves into shipping services. Shares of Stamps dropped as much as 58 percent on Friday in New York, touching their lowest since August 2016 and wiping off $2 billion in market value.”

During the earnings call, the management assured the shareholders that the business will continue to grow well. Despite their purported conviction in their business, I have not seen the management buy back their own shares yet. 

Consider the fact that they sold so much shares in 2018 yet are unwilling to buy back their own shares after the news broke out.

Is that not weird? If you’re following their money flow, what is it telling you?

How can I trust the management?

Example #4 – Best World International

Best World is a Singapore-based company selling personal care products in Singapore, Taiwan, China, Indonesia and other countries. The business is co-founded by Dora Hoan and Doreen Tan.

(Figure 1 – Table of Best World Buy-Back; source: self-compiled)

(Figure 2 – Share Price of Best World extracted as of 11/04/2019)

You’ll notice something about Dora and Doreen. They were able to pick near-bottom around the period of May to June. Subsequently, the company’s share price grew >100%.

It even hit an all-time high of >$3.

Even at $2.95 or so, the insiders did not sell a single share. They did not “trade” their shares, they kept it as long-term investments.

Today, there are many discussions about Best World’s business model.

But what’s undeniable is… since 4 April, the company and two co-founders spent nearly SGD $945k. That speaks a lot about their conviction. This is the kind of management behavior which shareholders should feel some level of comfort.

Summary

“Whenever a stock trades below intrinsic value, the insiders will always come to buy the shares. Nobody knows better about the company’s value than the insiders.”

If I find a undervalued company and the insider is selling, then the management is not confirming my opinion. If it is really undervalued, they should be buying.

I watch these actions carefully.  Like what I’ve mentioned earlier, we do not look at a single transaction, we look at the historical transactions too.

“What happened the last time when the insiders bought?”

Did they buy and nothing happens? Or something else?

In some companies, the insiders were able to pick the bottom, and they’ll buy a ton of stock before the share price rebounds. The company’s value is just within their knowledge.

If a company’s management announces that they are bullish on their shares, but are selling their shares, I won’t even get near that company.

Hope this article is helpful, if  it is, please share this around. It is my desire to spread my sharing with more people.

Disclaimer: I am a shareholder of Best World International Ltd (SGX:CGN)