Speculative stocks are always a risk. I don’t have to tell you that they offer a chance to watch your investment money disappear faster than a free ice cream cone on a mid-summer day. However, with risk, there’s always the chance of big rewards. Given the right circumstances, and a carefully chosen investment, your speculative investment could be your ticket to a winter home in a tropical paradise.
One time-tested way to find those excess returns is by following insider buying. With that in mind, let’s review the data to see whether insiders are buying their own shares today.
During the depths of the S&P 500’s plunge in March, the insider sell/buy ratio was 0.88, according to data from Insider Arbitrage. This marked the first time in 10 years that there were more insider buys than insider sells.
It proved to be an opportune time to buy as the S&P 500 has surged 42% from its March 23 trough.
More recently, the insider sell/buy ratio was 10.1. In other words, there were 10x more insider sells than buys.
Despite this unfavorable sell/buy ratio, there was one area of the market where insiders were buying hand over fist: Energy.
It makes sense.
Commodities are trading at their deepest discount to the S&P 500 in 50 years….
It’s no wonder energy insiders see clear value.
Two energy stocks in particular have seen strong insider buying.
Insider trading could be your window to future profits
Insider Buying in Continental Resources (CLR)
Continental Resources founder and Executive Chairman, Harold Hamm, recently acquired 2,679,849 shares of Continental Resources (CLR). He paid $17.77 per share for a total purchase price of ~$48 million.
This purchase follows another large purchase (~$73 million) that Hamm made prior to that. Clearly, he sees value in his company.
Counting these purchases, Hamm owns over 80% of shares outstanding of this $6 billion market cap fracking leader. The recent insider buying makes me wonder whether he is planning on taking the company private at some point in the near future.
Let’s take a step back and get familiar with CLR and its outlook.
CLR is an independent crude oil and natural gas company that was formed in 1967. The majority of CLR’s oil and natural gas production, as well as its proved reserves (53% of total), come from the North (the Bakken field of North Dakota and Montana). The balance of oil and gas production and proved reserves (47% of total) comes from the South (mainly Oklahoma).
When evaluating an oil and gas company in the current environment, the first and most important question to ask is, “Is there a bankruptcy risk?”
CLR does have a significant amount of net debt ($5.5 billion), especially in the context of how much cash flow the company generates. Since last summer, the company has generated over $3.0 billion of cash flow from operations. Due to the coronavirus plunge in crude prices, CLR cut its capex plans back and now plans to spend $1.2 billion (down 55% y/y). However, capex could be cut back further if needed.
Further, CLR has no meaningful debt maturities until 2022.
As a result, I’m comfortable that bankruptcy risk for CLR is low.
Now let’s consider the upside. First, the stock’s valuation at 15x forward earnings is not demanding considering the depressed operating environment.
Looking at the long-term chart, one can see CLR traded over 70 per share in 2018. Thus, there would be significant upside if (or when) the energy industry recovers.
When I’m evaluating investment opportunities, I’m looking for asymmetry. What does that mean? Limited downside and many multiples of upside in a positive scenario. With CLR, it looks like we have an asymmetric setup.
Insider Buying in W&T Offshore, Inc. (WTI)
W&T Offshore, Inc. (WTI) is another company with heavy insider buying and an asymmetric risk/reward setup.
Chairman, CEO and President Tracy Krohn recently acquired 632,334 shares at a price of $2.15 per share for a total cost of $1.4 million. In total, Krohn now owns 47,391,459 shares, or 33% of shares outstanding.
Separately, Director Virginia Boulet acquired 18,604 shares at a price of $2.20 per share for a total cost of $40,927. In total, Boulet owns 255,177 shares.
W&T Offshore, Inc. is an oil and gas exploration and production company. The company’s exploration operations are focused in the Gulf of Mexico, where it drills for oil and gas. The company engages in both deep-water drilling and shallow-water shelf drilling. While WTI drills for both crude oil and natural gas, crude accounts for most of the company’s revenue.
WTI’s situation is a little more precarious.
It has ~$520 million of net debt on its balance sheet but doesn’t have any meaningful maturities until 2022. Further, it has $48 million of cash on its balance sheet and a revolving line of credit for $135 million.
In 2016, the last time we saw a plunge in crude prices, WTI generated just $14 million of operating cash flow so we can expect something similar now. The company has cut capex drastically and only expects to spend $23 million over the next few months. As a result, I would expect the company’s near-term cash loss to be manageable given its cash balance.
If the energy markets recover over the next couple of years, WTI should trade considerably higher. In 2018, the share price traded as high as 9.84.
Again, we have an asymmetric opportunity. There is limited risk of bankruptcy in the near term yet, in a positive scenario, the stock would be multiples higher. To be fair, I think the risk of bankruptcy is higher for WTI than it is for CLR.
If you can stomach the volatility and appreciate asymmetric opportunities, WTI and CLR are both worth a speculative investment.