Persistent Anomaly, Consistent Profits

Over the years market practitioners and finance academics have discovered many anomalies in stock price movement. There have been such things as the Monday Effect, the January effect, the first week of the month effect, the last day of the month effect and other such tradable patterns. These patterns usually persist right up until the time they are published and become widely known. As an increasing number of traders move to take advantage of the pattern the pattern becomes full priced and disappears. There are two anomalies however that have stood the test of time and have never gone away and are not likely to ever go away. The first one is the value anomalies as seen in stocks trading at low price to book value ratios consistently outperforming the market. This has been studied, studied again and then taken up of further review. The out performance of low price to book value stocks has continued unabated in spite of the attempts of Efficient Market enthusiast to explain it away. It exists and will always exist for a few simple reasons. The first and most obvious is that corporations have actual value and if they trade below that the market will eventually correct the price. The second reason is that the price to book value returns are earned over longer period s of time and most market participants have too short a time frame to be interested in owning the shares long enough to profit from them. Hot Money loves short term anomalies that can be exploited over a few days or weeks but lacks the patience to exploit ones that takes years to develop. The other long running market anomalies that is unlikely to ever be over exploited or arbitraged away is that of insider trading. Insider buying and selling of shares has been very predictive since Victor Niederhoffer and Jim Lorie first studied the subject back in the 1960s. It works because it is based on that most precious commodity in market, inside information. The people running the company know more about the financial condition and prospects than anyone else and are in position to take advantage of this knowledge. Fortunately the strict disclosure laws make it possible for us to do the same. Once again because it is not short term in nature and profits are realized over months and years instead of days and weeks the vast majority of market participants ignore this very valuable information. It makes sense to combine these two proven long lived anomalies to search for stocks that trade below book value are seeing strong buying by the officers and directors that manage the company. One stocks that fits the bill is Halcon Resources (HK) an oil and gas company with substantial holdings in some of the largest unconventional shale field like the Bakken and Utica shale fields. The company is heavily indebted and there have been concerns about its ability to finance its projects. The company has raised cash through additional debt offerings and also sold some non-core assets at advantageous prices. Insiders seem to feel good about the prospects for a turnaround at Halcon as they have consistent large buyers of the stock in recent months. In the last month alone 8 different insiders including the CEO have combined to buy more than 250,000 shares of HK stock with the shares trading at just 80% of tangible book value. Silver Bay Realty trust came public earlier this year as a vehicle to invest in single family homes. Investors anticipated that the REIT will be able to earn high rates of income form a portfolio of properties purchased in depressed conditions and also see appreciation over time. It has not exactly worked as envisioned so far as repair time and costs to get the homes ready for move in are more than originally expected. SO far the high yields have not materialized. However the company does now own more than 5600 single family homes purchased at very advantageous prices. The stock currently sells for 90% of book value and about 80% of managements estimated net asset value based on comparable transactions. Officers and directors have been taking advantage of what they perceive as a sever undervaluation and have been active buyers of the shares in the open market. Silver Bay is also buying back its own shares and has repurchased 500,000 shares since July of this year. As property markets recover over the next decade this could turn out to be a spectacular investment for patient owners. Combining insider buying and value just makes sense for long term investors. If you can buy assets at a discount alongside the people running the company you should increase your odds of long term success in the markets.