Lit Fuse: Insider Buying in Energy

NEW YORK (TheStreet) -- Unless you're buying a company's shares for income and a worthwhile dividend you're most likely buying because you believe the stock has significant upside growth potential.

There are many metrics and gauges that help us determine when a stock is a good value and has been unjustly overlooked by the investment community.

Some people listen to financial analysts, some receive information from their brokerage firm, and many rely on their own experience, research and instincts.

Those are all important ways that help us to find value in whatever asset class we want to invest in. Yet we also need to ask some important questions, especially when it comes to the shares of companies we're considering.

Who is most likely to know the details of the financial condition of the company? Who spends each day guiding the decisions, knowing the business prospects and managing the expectations of the shareholders?

Which individuals know the competition? Who is more likely to know the prospects for the industry sector that this company, the one you're considering investing in, is a part of?

The answer is the insiders who work for that company, especially the operating officers who have to make the big decisions on a day-to-day basis.

When they're willing to invest a meaningful amount of their net worth in their company's stock they're showing shareholders that their financial interests are aligned with them.

This doesn't always mean that a company's share price is ready to turn around and head higher. It also doesn't mean that the officers and directors know where the stock's price bottom resides.

It usually does mean the insiders believe the stock is worth more than the market is currently valuing it. With their inside awareness of the company's current operating environment and earnings they can often see far enough down the road to know that the stock will eventually be more fairly priced.

Ready to Energize

One sector where a number of quality companies are not currently being treated with much enthusiasm or respect is the energy sector. Many of these companies are trading at such low valuations that if you didn't know the ins and outs of how they make money you wouldn't realize that the stock should be priced more generously.

Some insider buying in this sector is getting the attention of analysts, media and investors particularly at McDermott International ( MDR). MDR operates as an engineering, procurement, construction, and installation company worldwide. It focuses on designing and executing complex offshore oil and gas projects. The company employs 13,500. They provide designs and installation for fixed and floating structures, pipelines and subsea systems and shallow and deepwater construction services.

MDR operates in more than 20 countries and has a number of key joint ventures including one with a subsidiary of state-owned China Shipbuilding Industry.

On June 4 and 5, two officers and two company directors purchased $2,626,327 worth of MDR shares as prices ranging between $9.33 and $9.64. The 52-week low on the stock was intraday on June 4 at $9.04. So their timing was impeccable.

MDR is trading at a little over eight times forward earnings and at a trailing-12-month price-to-sales ratio of only 0.75 - a reading below 1 is a fairly reliable indicator that the share price is undervalued.

Their first quarter 2012 financial results demonstrated the earnings power of this cashed-up company and the profitable prospects going forward. Their balance sheet looks quite good. According to the company's press release:
As of March 31, 2012, McDermott reported total assets of approximately $3.1 billion. Included in this amount was $899.5 million of cash and cash equivalents, restricted cash and investments.
Net working capital, calculated as current assets less current liabilities, was $605.1 million. Additionally, total equity was almost $1.8 billion, or approximately 58% of total assets, with total debt of $92.2 million.

This helps explain why company insiders want to own shares of MDR. Two institutions are also big believers in the prospects for this company.

Artisan Partners Limited Partnership and FMR (a.k.a. Fidelity Investments) each own close to 6% of the outstanding shares of MDR as of March 30, for a combined investment of almost $357 million dollars.

MDR has a market cap of only $2.14 billion, so it isn't unreasonable to imagine a much larger company acquiring them to expand their international operations. Two names that come to mind are Schlumberger ( SLB) and Halliburton ( HAL).

Beyond MDR

There are other small-to-mid cap size energy companies who have recently seen an increase in insider buying.

They include Sandridge Energy ( SD), an independent oil and gas company based in Oklahoma. It recently saw one of their directors increase his direct and indirect ownership of the company's stock to an impressive 1.45 million shares.

Other insider transactions from the energy patch included Phillips 66 ( PSX), the company recently spun off by ConocoPhillips ( COP).

PSX is an independent downstream energy company, engaged in the refining and marketing of oil and gas, and also is in power generation, lubricants and other related activities.

When a sector as important as energy and energy services sees a marked increase in insider buying it behooves us to pay keen attention.

The companies mentioned in this article all have valuable operations and experienced management, so it's not surprising that insiders would be picking up more shares at bargain prices. View each company in the light of their profitability and earnings growth before you also consider opening your wallet and participate in the buying.

At the very least familiarize yourself with the more well-established candidates like McDermott, which in the past 52-weeks saw its shares trade as high as $21.69.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

At the time of publication, the author was long COP.

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