Empirical studies have proven that investors who mimic or "monkey," insider trading sentiment can beat the market by an average of 7 percentage points a year. While this strategy sounds simple enough, it is time-tested, as insider transactions and excess returns have exhibited a statistically significant correlation over the past 50 years. While insider sales typically dominate the headlines, it's more important to track insider purchases. As the old adage goes: there are many reasons for a corporate executive to sell shares of his or her company, but only one, very bullish reason for them to buy in.
One stock that has seen a round of purchasing activity in recent weeks is Chesapeake Energy Corporation (NYSE:CHK). Since the start of June of this year, five different Chesapeake insiders have bought shares of the natural gas exploration and production company. We'll briefly discuss the details below.
W. Archie Dunham: Aside from serving as the Independent Non-Executive Chairman at Chesapeake Energy, Mr. Dunham also sits on directorial posts at Union Pacific Corporation (NYSE:UNP), Louisiana-Pacific Corporation (NYSE:LPX), and Pride International, Inc. On the 14th and 18th of September, Mr. Dunham bought 75,000 shares of Chesapeake at an average cost of $19.99 a piece. Altogether, the $1.5 million transaction increased Dunham's holdings in the company by 29.8%; he now holds a little over 326,000 shares of Chesapeake worth a total of $6.3 million. It's worth noting that these stock purchases were non-deriviative in nature, meaning they were purchased on the open market. This is the most bullish of all insider trading signals.
K. Richard Davidson: Two months before his colleague boosted his ownership of Chesapeake, Richard Davidson made a smaller purchase. In early July, Mr. Davison, who has been on the company's Board of Directors since 2006, upped his stake by 2,000 shares at a price of $19.94 each. With the buy, Davidson now owns $3.8 million worth of Chesapeake stock. Since the transaction, which was his first of any kind since early 2011, shares of the company have lost 3.3%.
A. Merrill Miller Jr.: In late June of this year, Merrill Miller increased his total holdings of Chesapeake to 159,017 shares, with an open market purchase of 27,700 shares at an average price of $18.00 each. Aside from being a Director at the company, Mr. Miller also serves as the President and CEO of National-Oilwell Varco, Inc. (NYSE:NOV). In the time since Miller's bullish bet on Chesapeake, its shares have returned 7.7%.
Brad R. Martin: In the same week as Mr. Miller's transaction, Brad Martin purchased a stake in the natural gas company, totaling 20,000 shares worth $355,000. Altogether, this buy increased the Director's holdings in Chesapeake by 175%, and were purchased at an average price of $17.75 a share. Consequently, Mr. Martin has achieved an extra 1.5 percentage points in absolute returns over Merrill Miller since the purchase.
C. Steven Dixon: Last but certainly not least, Steven Dixon initiated a small position in Chesapeake in the second week of June, amounting to a total of 860 shares at an average purchase price of $17.51 a piece. Mr. Dixon, who serves as the company's Executive Vice President of Operations and Geosciences and its Chief Operating Officer, has made 10.7% in a little over three months time. Due to his integral positioning within Chesapeake's management structure, he remains a strong "monkeying" candidate going forward.
In the midst of these insider transactions, Chesapeake Energy reported its second quarter earnings on August 6th. In the release, the company announced adjusted EPS of 6 cents, which was a 92.1% decline from the $0.76 it reported in Q2 2011. These earnings also came in 1 cent below analysts' expectations, though revenues actually exceeded consensus. Chesapeake reported $3.4 billion in revenues, up 3% year-over-year, and 41.7% above analysts' estimates. Additionally, the company finished a $4.7 billion asset sale, and said it expected to sell $7 billion in Permian Basin assets over the third quarter. Altogether, Chesapeake expects to sell between $13 billion and $14 billion in assets by the end of the current fiscal year, allowing it to repay $4 billion in term loans and fulfill the rest of its 2012 debt reduction goal.
Over the next five years, early estimates expect Chesapeake to experience annual EPS growth of 7.8%, a vast improvement over the annualized declines (-11.8%) it has endured over the past half-decade. This modest growth forecast is middle-of-the-road in comparison to Chesapeake's competitors including: EOG Resources, Inc. (NYSE:EOG) at 13.8%, Devon Energy Corporation (NYSE:DVN) at 6.5%, Anadarko Petroleum Corporation (NYSE:APC) at 4.9%, BP plc (NYSE:BP)at 3.1%, ConocoPhillips (NYSE:COP) at -2.0%.
From a valuation standpoint, it appears that investors are underappreciating Chesapeake's growth potential, as its shares currently trade at a PEG ratio of 0.82; typically any figure below 1 signals an undervaluation. More importantly, the company's earnings growth multiple is also below the likes of EOG Resources (1.61), Devon Energy (1.56), Anadarko Petroleum (3.43), and BP (2.57). Additionally, Chesapeake's P/E valuation (6.4X) is trading at a 31.5% discount in relation to its own five year historical average (9.3X). This attractive differential is better than many of its aforementioned competitors operating in the oil and gas E&P industry including: Devon Energy (+170.3%), BP (-10.5%), and ConocoPhillips (-16.0%). Only EOG Resources (-54.1%) trades at a cheaper discount than Chesapeake.
Despite its relative instability in recent years, Chesapeake Energy does offer a decent dividend yield of 1.81% to income-seeking investors. With a payout ratio near 10%, these payments look sustainable going forward. Chesapeake's yield is below those of BP (4.44%) and ConocoPhillips (4.55%), but above EOG Resources (0.60%), Devon Energy (1.33%), and Anadarko Petroleum (0.51%).
Aside from activist investor Carl Icahn, other hedge fund managers that are long Chesapeake include: Mason Hawkins with a $1.7 billion position, John Rogers, Jeffrey Tannenbaum, David Dreman, and Ken Griffin. It appears that they are noticing the stock's attractive valuation, as it is trading at a reasonable price with regard to its forecasted earnings growth. The recent round of insider buying activity surrounding Chesapeake only adds to its bullish outlook. For a complete look at the insider and hedge fund sentiment surrounding this stock, continue reading here.