It is never wise to blindly follow a hedge fund manager into a position. There are multiple reasons for this.
First of all, unless you have access to quarterly investment letters from funds, you have no idea why the hedge fund manager initiated the position in the first place.
Second, 13Fs and investment letters usually come out several weeks after the quarter ends, which means positions are stale and the market may have already eliminated the mispricing opportunity or, in an even more extreme case, the hedge fund could have already moved out of the position.
Third, and this is probably the most important part, if you have not conducted your own due diligence on a particular stock, you are at the mercy of the market in regard to future market developments.
If you blindly follow a hedge fund manager into a position, and the next quarter the company comes out with a profit warning, how do you know whether or not the profit warning is terminal? Or if the stock price falls by 20% over the space of 30 days for no apparent reason, how do you justify holding on to the position yourself? By the time you find out whether or not the hedge fund still owns the position, it could be too late.
While you should not follow hedge funds into stocks, however, following management is a different kettle of fish altogether.
One group of investors to follow
Management has an unrivaled view of a company and its prospects. If several members of the management team decide they want to increase their stakes in the company by buying shares on the open market, it is a strong signal they believe the stock is undervalued.
Of course, such buying is not always a guarantee the business is undervalued. Most company managers are not stock pickers, so they may be unable to accurately value the business. If buying is relatively insignificant compared to salaries, it may be nothing more than an attempt to prop up the stock price.
Even if you are following management, it pays to do extra research, as you should do every time you invest in a company. Still, management buying is generally a great sign that a company’s shares are undervalued.
The biggest buyers
Some companies have seen significant insider buying over the past three months, indicating management believes the shares of these businesses are undervalued at a time when the rest of the market is trading at a significant premium.
S&W Seed Co. (SANW, Financial) has seen the most significant buying with 10% owner Wynnefield Partners Small Cap buying 45 times over the past three months. Interestingly, only one value hedge fund has a stake in the business:Â Michael Price (Trades, Portfolio)’s MFP Investors owns 3.2 million shares. Seritage Growth Properties (SRG, Financial) has also seen strong buying with 31 insider trades amounting to $18.6 million. Substantially all of this buying comes from Bruce Berkowitz (Trades, Portfolio)’s Fairholme Capital, which owns 3.7 million shares of the company, accounting for 15.3% of the overall portfolio. International Flavors & Fragrances Inc. (IFF, Financial) looks cheap according to 10% owner Winder Investment Pte. Ltd., which spent approximately $154 million buying stock 28 times over the past three months.
The company that has seen the most significant management buying, but not buying by insider hedge funds, is TransDigm Group Inc. (TDG, Financial). Over the past three months, TransDigm’s management has spent $24.5 million buying shares of the company. Almost all of this firepower comes from director Robert Small.
Another company that has seen substantial insider buying that has not been bulked up by hedge funds is manufacturer and marketer of organic food products SunOpta Inc. (STKL, Financial). Over the past three months, management has spent $11.6 million adding to positions. The company’s directors, president, CEO and chief human resources officer have all increased their stakes, displaying confidence in the company and its outlook.
Disclosure:Â The author owns no stock mentioned.
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