Why This Stock Is a Winner

If you could wave a magic wand and bestow just one characteristic on all of your investments, what would it be? (Besides the ability to print money, that is.)

I began thinking about this after reading Tom Gardner's "A 25-Bagger in Five Years," in which he identified three factors that give a company the chance to achieve outsized gains -- like 25-baggers that turn $5,000 into $125,000. Of the three he mentions (and actively screens for in Motley Fool Hidden Gems), one characteristic is most important to me: a high level of insider ownership.

Why it matters
But this makes sense, right? Think about any of your major personal investments:

  1. You are a stockholder, with a good deal of your wealth riding on this company's performance.
  2. Founders and managers with high levels of ownership also have their wealth riding on the company's performance.
  3. They are doing everything they can to increase the long-term value of their stock -- which is also your stock.

Having a wonderful time ...
With their reputations, their livelihoods, and their careers on the line, you can be fairly sure these managers and board members are motivated to do what's best for the company. It's like having someone on the inside, working for you every day.

What is the opposite of that? Businesses in which management has very little tied up in company stock. Where actions may be motivated by things that actually harm the stock's performance -- office politics, power plays, or working with an eye on the clock (is it 5:00 yet?) -- than on improving the business model. Or, even worse, management that rewards itself with high salaries and bonuses that have nothing to do with outstanding performance.

Now, don't be chagrined if you find that some of your larger holdings have a low percentage of insider ownership. For example, Citigroup (NYSE: C  ) is only 0.41% owned by insiders. JPMorgan Chase (NYSE: JPM  ) sports just 0.86% insider ownership. The sheer size of those companies makes it awfully tough for anyone to own a significant share of the entire business.

But small companies are a different story. In small-cap land, CEOs and managers with high levels of ownership are much more likely to rise above the mediocrity and work toward the common goal of great stock performance.

For instance
I ran a screen for some companies with high insider ownership, but went a bit beyond that. The following businesses also have strong sales and earnings growth, high margins, and high returns on equity (ROE) -- a potentially winning combination.

Company

Insider Ownership

Sales Growth*

EPS Growth*

Net Margin*

ROE*

Morningstar (Nasdaq: MORN  )

63%

37%

45%

18%

22%

True Religion (Nasdaq: TRLG  )

26%

35%

39%

16%

34%

Dolby (NYSE: DLB  )

55%

33%

55%

31%

22%

NorthStar Realty (NYSE: NRF  )

17%

63%

415%

135%

26%

Crocs (Nasdaq: CROX  )

16%

100%

62%

15%

40%

*Trailing 12 months. Data provided by Capital IQ, a division of Standard & Poor's.

And beyond
Insider ownership, particularly in smaller companies, is one positive indicator in the quest for tomorrow's multibaggers. There are many more, of course, but insider ownership is one of the core variables we screen for in Hidden Gems.

The process is working. Tom and his analysts are averaging 36% total returns for their recommendations, versus 12% for identical amounts invested in the S&P 500. We invite you to take a free trial and look through all of our active recommendations. There's no obligation to subscribe.

This article was originally published on Feb. 21, 2006. It has been updated.

Rex Moore thinks Jack Bauer would make quick work of Chuck Norris. At the time of publication, he owned no companies mentioned in this article. JPMorgan Chase is an Income Investor recommendation. Morningstar and Dolby are Stock Advisor picks. The Fool owns shares of Morningstar. The Motley Fool is investors helping investors.


Read/Post Comments (2) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 23, 2008, at 9:48 AM, sdasdasfas wrote:

    You are wrong Morningstar will out

    of bussiness in 3 years. The company

    is under 3 INVESTIGATION.

    Most of their data are fake.

    Double interest.

  • Report this Comment On May 27, 2008, at 5:39 PM, 102971 wrote:

    I am loathe to accept sdasdasfas's comments simply because they are so rambling.

    However, there have been cases in the past when the high insider ownership causes those owners to inflate results simply because it increases the value of their holdings. It is wise to keep an eye on these companies and take care when that insider ownership starts selling share.

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