In most cases, insider trading activity is an important indicator to track, as it truly gives individual investors a look at the internal workings of a company, sometimes before it is widespread knowledge. While blatant forms (such as this case) of insider trading on market-moving non-public information are illegal, the overwhelming majority of these transactions are perfectly within the rights of the law. Take these statistics for example: out of the more than 200,000 insider transactions that occurred in 2010, only five were deemed as worthy of prosecution by the SEC.
But what does all of this information mean exactly? Well, for starters it means that individual investors can mimic, or “monkey,” these insider transactions to achieve excess returns of up to 7.0% a year. While this strategy sounds difficult and time-consuming, it actually isn’t as daunting as it seems. By utilizing our database that tracks insiders’ Form 4 filings with the SEC, it’s possible to formulate an effective market-beating strategy.
On Wednesday of this week, two insiders at Hot Topic, Inc. (NASDAQ:HOTT) purchased a total of 103,106 shares of their company at an average purchase price of $9.12 a piece. The transactions were initiated by two of Hot Topic’s directors, R. Steven Becker and A. Matthew Drapkin, who are the co-founders of the Dallas-based small cap fund Becker Drapkin Management. Both directors also hold posts at a number of other publicly traded companies, including Ruby Tuesday, Inc. (NYSE:RT) and Pixelworks, Inc. (NASDAQ:PXLW).
Interestingly, shares of Hot Topic did experience a moderate pop on Thursday with prices rising by more than 4.0% to $9.27, though these gains were subsequently lost in after hours trading. Over the longer term, though, the teen retailer has still been a splendid investment. Since the start of 2012, its shares have returned 40.2%, outpacing the apparel stores industry average (38.3%), and other retailers in this space, including Abercrombie & Fitch Co. (NYSE:ANF) at -21.1%, Aeropostale, Inc. (NYSE:ARO) at -3.9%, and The Buckle, Inc. (NYSE:BKE) at 11.5%. In fact, out of its closest competitors, only American Eagle Outfitters (NYSE:AEO) at 54.7%, has had a better year than Hot Topic.
When looking at the company from a quantitative standpoint, it appears that much of this appreciation has been driven by its earnings, which have grown by 77.6% this calendar year. By the end of 2012, the Street is expecting the retailer to reach an EPS of 43 cents a share, which would mark a 112.5% increase from the $0.20 it reported last year. Analysts are expecting this growth to slow in 2013, as early estimates predict year-end EPS at this time will be between 48 and 54 cents a share. It is notable that Hot Topic’s two-year expected earnings growth rate (75.0%) trumps the likes of Abercrombie & Fitch (18.2%), Aeropostale (18.9%), Buckle (4.4%), and American Eagle Outfitters (38.4%).
Despite Hot Topic’s promising future, shares of the retailer still appear to be undervalued, as they sport a PEG ratio of 1.17. This valuation is below each of Hot Topic’s aforementioned competitors by an average of 39.4% – an impressive discount indeed. If the company can consistently meet its EPS estimates over the next 12-16 months, there is a strong possibility that future gains are in store as earnings valuations converge.
In the hedge fund industry, 14 money managers currently hold shares of Hot Topic in their portfolios. The most prominent bulls of this bunch are Joel Greenblatt, Steven Cohen, Jim Simons, and Cliff Asness. For a complete listing of hedge funds’ holdings in Hot Topic, continue reading here.