Promising growth potential of the company’s business model sometimes leads insiders to increase their stakes in the company. However, the same is not true every time an insider makes a purchase. I don’t agree with the insiders at MFA Financial, Inc. (NYSE:MFA), ARMOUR Residential REIT, Inc. (NYSE:ARR) and Javelin Mortgage Investment Corp (NYSE:JMI). I feel these companies offer little growth potential in the coming future. Therefore, it’s important to distinguish between the insider purchases that actually signal bullishness from the ones that don’t.
Recent insider activity
MFA Financial, Inc. (NYSE:MFA) saw three of its executives increase their stakes on May 29, 2013. Two executive vice presidents and the president himself bought 20,000 shares of the company altogether. Knutson Craig and Gorin William bought shares from the open market, while Freydberg Ronald’s purchase was not open market; however, he spent $85,600 to purchase 10,000 shares.
Similarly, on May 29, 2013, ARMOUR Residential REIT, Inc. (NYSE:ARR) reported two of its executives buying 10,000 shares of the company at an average price of $4.99 per share. These were also open market acquisitions and not part of the annual compensation given to the top executives.
Javelin Mortgage Investment Corp (NYSE:JMI) is a sister concern of ARMOUR Residential REIT, Inc. (NYSE:ARR), as they are both managed by the same external manager. It too reported four of its officers to have bought 7,200 shares altogether on May 29, 2013. Like the above two purchase, these were also open market purchase and not part of executive compensation.
Why it’s fool’s gold
So, what are the factors that lead me to think that investors should not take bullish signals from the aforementioned insider purchases?
All the three companies mentioned above are mortgage REITs. Their profitability is highly dependent on macroeconomic factors of which management has little or no control. The only stock price driver that I could think of in the near and intermediate future is the Fed’s intervention in the Agency MBS market.
I believe the Fed might be exiting the Agency MBS markets soon. The markets have already started to price in the effects, and as a result mortgage rates have started climbing. Once the Fed exits, you will see more volatility in the rates, which will put downward pressure on the book values of mortgage REITs.
In particular, MFA Financial, Inc. (NYSE:MFA) has constructed its portfolio in such a way that it will be at a disadvantage if the rates start climbing, which they have. You can see its projected net interest income to fall by around 4% if the rates increase 50 bps. Further, its most recent quarter’s cash dividend coverage ratio comes out to be 0.96 times, which means the company is does not generate enough cash from its operations to support its current dividends.
Further, I don’t see any repositioning effort taking place in the investment portfolio. With nothing going in the favor for MFA Financial, Inc. (NYSE:MFA), you can see what signals insiders want to give.
Similarly, ARMOUR Residential REIT, Inc. (NYSE:ARR) is a mortgage REIT for which nothing has been going in its favor. It reported around an 8% plunge in its book value at the end of the first quarter, and till now no repositioning efforts have been made for its investment portfolio either. During these times, when we see rates are climbing, you can expect ARMOUR Residential REIT, Inc. (NYSE:ARR) to report a 4% decline in its net interest income. While its current cash dividend coverage ratio of 1.15 times can absorb some hit, I believe it’s not sufficient in the long run. Therefore, the insider buying at ARMOUR Residential REIT, Inc. (NYSE:ARR) is giving a false signal.
Same is the case with Javelin Mortgage Investment Corp (NYSE:JMI). Javelin Mortgage Investment Corp (NYSE:JMI) has positioned its portfolio in a way that it will benefit from declining interest rates. However, the opposite will be happening during the second quarter of the current year. Therefore, I expect up to a 7.6% decline in its projected interest income. The only positive I could come up with was its healthy cash dividend coverage ratio of 1.4 times. Therefore, even after a moderate hit, you can expect the company to continue its current dividends. However, the drop in book value, coupled with the anticipated decrease in net interest income, should be a cause of concern for the insiders rather than a cause of growth.
Conclusion
I recommend investors dig deeper into every insider buy, and the respective company’s growth potential and don’t get fooled by insiders’ signals.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Insiders Buying Doesn’t Always Mean The Same Thing originally appeared on Fool.com is written by Adnan Khan.
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