Time to Start Believing Insiders in the Financial Sector Again

By Michael Brush
Exclusively for InvestorIdeas.com
January 31, 2008

Insiders in the financial sector did a lousy job of alerting us to the subprime-induced credit crisis that would take out the market. Instead, they gave us plenty of false signals.

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Here are just a few examples:

• Bear Stearns (BSC) director Paul Novelly spent $7.4 million on 50,000 shares of his company’s stock back in March at $150 a piece. He was recently down about $3.8 million on the position.
• Thornburg Mortgage (TMA) chief executive Garrett Thornburg was recently out over $13 million on 2007 purchases of his company’s stock.
• Citigroup (C) executive Thomas Maheras purchased $3.8 million worth of his bank’s stock at $51 last March. He’s gone from the bank now. But if he still holds the position, he’s down about $1.9 million.
• Security Bank (SBKC) director Benjamin Griffith was recently down about $5 million on purchases he made in his bank’s stock last year.

The list goes on and on. Thanks guys.

Now, though, I think it might be time to start believing in sizable purchases made in the financial sector – especially a recent round of buying at E*Trade Financial (ETFC), Raymond James Financial (RJF) and Citigroup.

Why start believing in financial sector insiders now? After all, they were the very ones who should have been smart enough not to buy their stocks right before they tanked anywhere from 50% to 70%.

Here’s my short list of reasons.

• No one really knows for sure but I’m going to guess the worst of the subprime-related bad news will soon be behind us. We’ve had two quarters of big write downs. And while there likely will be more to come, a large chunk of it is already behind us – or already priced in to stocks.
• The Fed just slashed interest rates 1.25 percentage points in a week, after cutting rates a percentage point during September through December. Goldman Sachs (GS) economist Andrew Tilton expects another half a percentage point cut by midyear. That’s aggressive rate cutting which favors banks and brokerages in two ways. It lowers the cost of their borrowing, and it should spur advances in stocks which boosts profits.  
• Sentiment is extremely negative and stocks look cheap. Insiders, overall, continue to be bullish in their buying and selling. Again, these factors point to a rising stock market, and rising interest in stocks. This is good for profits at brokerages and money management shops who earn more when assets under management increase and when underwriting picks up.

Now here’s a quick look at three recent insider picks in the financial sector.

E*Trade Financial

The stock of this online brokerage has been hammered because of exposure to subprime-backed debt instruments. E*Trade stock is down over 60% in the past few months. It now trades for about .67 times book value.

A big reason E*Trade stock is so cheap: Investors worry about bankruptcy. But Morningstar (MORN) analyst Jamie Peters doesn’t see that as a likely outcome. “While the bankruptcy risk is not zero and we think this stock is only suitable for risk-tolerant investors, we believe E*Trade will likely survive this mess,” she says.

Insiders certainly agree. Directors – the entire board, in fact -- put $1.9 million worth of their money into the stock on January 29. E*Trade is backed in its turnaround efforts by Citadel Investments, which owns about 18% of the company and has a seat on the board.

Raymond James Financial

So far, this St. Petersburg, Florida-based brokerage has avoided any direct exposure to the subprime mess. That’s a positive right there. But its stock has been taken down nevertheless. At $27.50, it is off nearly 25% from highs in early December.

Insiders see opportunity in the pullback. Earlier this week they bought $3 million worth of the stock for about $26-$27 per share.

The biggest buyer was vice chairman Francis Godbold who put $2.6 million into the stock. Godbold has a great record for opportune buys. Raymond James Financial stock has typically advanced 21% in the six months following his purchases, according to Thomson Financial. Two senior managers also put about $375,000 into the stock.

In an earnings call last week, Raymond James chief Thomas James told investors he thought the strength of his company's business was not reflected in the stock price.

Among the big Wall Street brokerages and banks, Citigroup stands out for the damage it has sustained in subprime meltdown. It took a $10 billion loss in the fourth quarter and reported earnings of just $3.8 billion for last year, compared to $21.1 billion in earnings for 2006. The stock, of course, has been hammered -- falling to $28 recently from $55 last May.

But Citigroup is still a global powerhouse with a sizeable deposit base, and its profitability will increase because of the aggressive interest rate cuts. “We remain convinced that Citigroup is a bargain at current levels,” says Morningstar analyst Ganesh Rathnam.

Rathnam figures that Citigroup took the proverbial big bath in the fourth quarter, when new management decided to get all the bad news out of the way. “Despite the expected near-term struggles, we'd eagerly invest in Citigroup's shares at a suitable discount to intrinsic value,” he says. The recent stock price provides such a discount.

Citigroup’s chief executive of Latin America and Mexico Manuel Medina-Mora obviously agrees. He bought $5 million worth of the stock on January 24. It was the largest purchase by insider during the past five years, according to InsiderScore.com.

The bottom line: I don’t believe I can call the bottom in financial stocks, let alone the overall market. But I do believe that these insider purchases are telling us you will see profits in these three names if you buy now and are patient enough to wait a year or two.

Disclaimer At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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