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Heavy Insider Buying at These Three Struggling Companies; Are They Ready to Rebound?

All major U.S. stock indexes closed in the red on Tuesday, primarily owing to the struggling healthcare industry and several disappointing third-quarter earnings reports. The Dow Jones Industrial Average lost 13.43 points or 0.08%, while the Standard and Poor’s 500 Index closed 0.14% in the red. It appears that the ongoing third-quarter earnings season and the presidential-campaign scrutiny of prescription drug prices are the key drivers of the U.S. stock markets at the moment. At times when there are not so many global factors that drive the market, the insider trading activity might provide useful insights about different companies’ prospects. In fact, the likelihood that the recent insider trades are linked to firm-specific developments rather than to the broader stock market sentiment is higher than it was during the recent market correction. Therefore, this article will discuss the insider buying activity at three companies and will attempt to unveil potential reasons that might explain the bullish moves made by these companies’ insiders.

Insider Trading

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Most investors can’t outperform the stock market by individually picking stocks because stock returns aren’t evenly distributed. A randomly picked stock has only a 35% to 45% chance (depending on the investment horizon) to outperform the market. There are a few exceptions, one of which is when it comes to purchases made by corporate insiders. Academic research has shown that certain insider purchases historically outperformed the market by an average of seven percentage points per year. This effect is more pronounced in small-cap stocks. Another exception is the small-cap stock picks of hedge funds. Our research has shown that the 15 most popular small-cap stocks among hedge funds outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward testing the performance of these stock picks since the end of August 2012 and they have returned more than 102% over the ensuing three years, outperforming the S&P 500 Index by more than 53 percentage points (read the details here). The trick is focusing only on the best small-cap stock picks of funds, not their large-cap stock picks which are extensively covered by analysts and followed by almost everybody.

Moving on the potential stocks to buy, KMG Chemicals Inc. (NYSE:KMG) saw two different insiders acquire stock this week. Vice President and General Counsel Roger C. Jackson acquired 2,000 shares this Monday at a price of $20.15 per share and currently owns 72,553 shares. Furthermore, President and Chief Executive Officer Christopher T. Fraser purchased 2,500 shares on the same day at $20.30 apiece. Following the recent acquisition, the executive currently holds a stake of 94,576 shares. The shares of KMG Chemicals Inc. (NYSE:KMG) are currently trading at relatively the same price level they were trading at the beginning of the year, after losing 30% over the past six-month period. On October 14, the provider of specialty chemicals revealed its financial results for the fourth quarter and fiscal year that ended July 31. The company reported GAAP earnings per share (EPS) of $1.03 on net sales of $320.5 million for fiscal 2015, compared to a loss of $0.09 on net sales of $353.4 million reported a year ago. All in all, it seems that the aforementioned executives are buying shares on weakness. Douglas T. Granat’s Trigran Investments is the top shareholder of KMG Chemicals Inc. (NYSE:KMG) within our database at the end the second quarter, holding 1.33 million shares.

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The next page of the article will discuss the insider buying activity at two struggling companies.

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