Insiders Are Buying DPL. Should You?

As Peter Lynch once said, "Insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise."

Insider buying can often help you screen for great stock ideas, particularly when you notice an executive or director buying shares on the open market, just like you or me. It's too easy for management to build a sizable stake in the company by simply exercising stock options. On the other hand, when execs open up their wallets and pay cold, hard cash for shares -- especially $500,000 or more -- Fools ought to take notice.

Bear in mind that insider buying alone is not a compelling enough reason to purchase shares. For all their inside information, managers may not be the best judge of the company's actual worth, especially with a big chunk of their personal wealth on the line.

Consider management buying a signal that something good might happen for the company. Then decide for yourself whether the stock is truly cheap. A pair of quick-and-dirty numbers can help kickstart this process: the company's free cash flow yield, and the stock's distance from its 52-week low.

To calculate the free cash flow yield, divide the company's trailing-12-month free cash flow by its market cap. This metric resembles the dividend yield, but it measures all of the excess cash generated by the company, not just the amount paid out to shareholders. As long as the company's prospects look stable, the higher the free cash flow yield, the better. Renowned Fairholme fund manager Bruce Berkowitz uses a 10% free cash flow yield as a rough guide to determine whether a stock is cheap.

The 52-week low is more of a measure of market sentiment toward the company than an indicator of value. Generally speaking, it's better to buy when the stock remains out of favor than after it has come roaring back from the bottom.

DPL (NYSE: DPL) Executive VP Gary Stephenson bought more than $600,000 worth of stock on the open market in mid-May, at an average price just over $27. Let's see whether you might want to consider following his lead:

Source: Capital IQ, a division of Standard & Poor's and author calculations. All dollar amounts in millions, except stock price.

During the past three months, few insiders have many any notable buys within this peer group of utilities. DPL's stock remains within shouting distance of its 52-week low, and it's now trading below the price at which Stephenson bought shares. DPL also has a 12.6% free cash flow yield, which looks attractive compared to its peers. Given all these factors, DPL looks like it's worth a close look.

The inside scoop
A large stock purchase from an insider is even better than a hot stock tip. Someone who knows the company intimately has made the decision to risk a significant chunk of his or her own money on its success. I'd much prefer to buy shares of a company where management actively invests alongside me, rather than collecting stock options just for showing up.

Remember, Fools, insider buying is not the only measure you need to consider. It's only a starting point for your own additional research. Have any thoughts on DPL? Share them with the community in the comments section below.