Insiders of companies sell their stock for many reasons. It could be to buy a house, a new car, pay down debt and so on. But there is only one reason why they buy: because they think the price of the stock will go up. Who is there to better know about the company and its prospects than its senior management and executives? As Peter Lynch said in his book “One Up On Wall Street”:
“There’s no better tipoff to the probable success of a stock than that people in the company are putting their own money into it. In general, corporate insiders are net sellers, and they normally sell 2.3 shares to every one share that they buy. After the 1,000-point drop from August to October, 1987, it was reassuring to discover that there were four shares bought to every one share sold by insiders across the board.”
In more recent times, insider buying spiked after the large drop in markets in late 2008 and early 2009. Once again, during the last correction in 2011, insider buying spiked.
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- CRR 15-Year Financial Data
- The intrinsic value of CRR
- Peter Lynch Chart of CRR
In the GuruFocus All-In-One Screener, there is a pre-defined screen called “CEO buys after Price Drop > 20%”. The only result from the screen is Carbo Ceramics Inc (CRR). The stock is down over 30 percent since its peak in early July. Instead of running for the exits, insiders were buying.
The most notable of the buyers was Gary Kolstad, president and CEO of the company. There are eight insider buys of his on record at GuruFocus, and all of them have resulted in gains, including the most recent purchase on August 8 for $103.36. The stock reached a bottom of $100.28 on August 5 and closed today, August 22, at $104.38.
Carbo is the world’s largest supplier of ceramic proppant. Proppants are added to fracking fluid used to fracture shale rock formations to release oil and natural gas. Studies estimate that up to 80 percent of natural gas wells drilled in the next decade will require hydraulic fracturing to properly complete well setup. Carbo is also a provider of the industry’s most popular fracture simulation software, and a provider of fracture design and consulting services, and a broad range of technologies for spill prevention, containment and countermeasures.
Carbo has some of the highest scores when it comes to Business Predictability (5/5), Financial Strength (8/10) and Profitability & Growth (9/10). The company has a very strong balance sheet with $46.4 million in cash and no debt. Revenue has been increasing at a steady 14.3 percent over the past ten years. Earnings have been growing at annual rates of 12.4 for the past 10 years, 13.6 percent for the past 5 years, and 19.3 percent over the past year.
The big negative about the company has been it decreasing margins. Operating margins have been decreasing at an annual rate of 4.54 percent over the past five years.
Transporting costs from the supplier to the well site is a significant component in the cost of proppants. Carbo had the following to say in its latest quarterly report:
“Distribution of proppant to the well site remains an important part of the Carbo service offering to our clients. A recent challenge the industry is facing is a tight supply of trucking sevices in a certain areas to transport proppant to the well site. Given this industry issue, we may likely face increased transportation costs and delivery issues.”
The company is continuing to build out it distribution network and is working on increasing capacity. Ceramic proppant demand in the second quarter exceeded Carbo’s capacity and its finished goods inventory had to be drawn down. Its expansion efforts can be detected in the sharp rise in capital expenditures. In 2012, capex spending was only $77.2 million and has jumped to $154.3 over the past twelve months. Capex spending is likely to come back down after this year if the company continues to follow the pattern displayed in its cash flow statements. The spending has a trend of rising for two years and falling for two years. One of its production lines to increase capacity is now operational. The building of another line and a retrofitting of an existing plant for new technology is currently underway.
The stock currently has a P/E ratio of 26.00. Its 5-year median P/E is 25.3. The stock’s price had gotten ahead of itself and needed to be corrected. The large drop in the price puts it back in line with its median P/E ratio. At its median P/E, the price would be $101.80. According the GuruFocus DCF Calculator, earnings would need to grow at an annual rate of 18.63 percent in order to justify its current price. Its earnings grew at a rate of 19.3 percent over the past year, but historically, earnings have grown at around 12 to 13 percent. Based on earnings, the stock is still slightly overvalued and needs to come back down a little more.
Carbo Ceramics is the world leader in ceramic proppant and has the highest rating for Business Predictability. The average annual gains for companies with high predictability has been 12.1 percent when back-testing the stocks with the highest rating. Also only 3 percent of those companies have experienced a loss if held for ten years. As a value investor, I think the stock needs to come down a little bit more, but the insider activity indicates that management believes the performance will help support the stock.
For more investing ideas, insider trades can be monitored at GuruFocus through the following link: Insider Trade. Sometimes patterns can be spotted in the trades such as the successful insider buying of Carbo Ceramic’s CEO, Gary Kolstad. Insider trades can also help provide insight into distressed companies. Peter Lynch says that if insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months.
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