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 things that give a company the chance to achieve outsized gains over the years -- like 25-baggers that turn $5,000 into $125,000. Of the three he mentions, 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 -- of 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 where management has very little tied up in company stock. Where actions may be motivated by things that actually harm the stock's performance, such as office politics, power plays, or working more 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, General Electric (NYSE: GE  ) is just 0.05% owned by insiders, and Altria (NYSE: MO  ) barely more at 0.14%. Their sheer size makes it awfully tough for anyone to own a significant share of the entire business.

But smaller companies are a much 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 -- a potentially winning combination.

Company

Insider
Ownership

Sales
Growth*

EPS Growth*

Net
Margin*

ROE*

DryShips (Nasdaq: DRYS  )

19%

156%

135%

77%

60%

Thinkorswim Group (Nasdaq: SWIM  )

17%

17%

154%

16%

31%

Axsys Technologies (Nasdaq: AXYS  )

17%

43%

81%

11%

15%

 Starent Networks (Nasdaq: STAR  )

10%

74%

599%

24%

20%

Genoptix (Nasdaq: GXDX  )

15%

96%

127%

27%

28%

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

And beyond
Insider ownership, especially 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. After more than five years, the team’s recommendations are beating the S&P 500 by an average of eight percentage points each. We invite you to take a free trial to 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 is a Stock Advisor analyst and runs the Foolish 8 screens for Hidden Gems. At the time of publication, he owned no companies mentioned in this article. Axsys is a Stock Advisor recommendation. The Fool is investors helping investors.


Read/Post Comments (6) | Recommend This Article (45)

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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 March 18, 2009, at 3:03 PM, apoorinvestor wrote:

    Please don't tout DRYSHIPS. The volatility alone almost guarantees a loss on investment.

  • Report this Comment On March 18, 2009, at 4:30 PM, Belgio wrote:

    The article hits a strong point. Having such a high ownership percentage by the manager also allows him latitude that most companies lack to make strong decisions. It may explain why DRYS is at the top of its class in key performance ratio. Larger companies with less insider interest tend to be clouded in bureaucracy. They are unable to react as quickly to take advantage of economic opportunity.

    Dryships main issue right now is liquidity. It has a tremendous hard asset base to liquidate to generate cash. If it pulls out of the recession without having to liquidate too many assets or dilute its shareholders with its recent registration lot, this company will resume its stellar performance and the return to shareholders will be very strong.

    The volatility is very high. It is considered a distressed stock. High volatility does not imply though that the investment is a sure loss.

  • Report this Comment On March 18, 2009, at 5:25 PM, TSIF wrote:

    The idea that inside investors care about he company is a point well made, but not always true. Economou has taken this company to the precipice and could care less. His goal of buying ships from family members and his own shell company have all compounded with the debt load DRYS already has to bring a once profitable company to it's knees at economically the worse possible time. The dance with creditors and the decision to issue more dilutive shares will keep this stock fully depressed for years, assuming bankruptcy doesn't finish it. When DRY's use to move up or down all the shippers followed it. I am glad to see the symbiotic link is broken. Davy Jones Locker it is.

  • Report this Comment On March 18, 2009, at 9:12 PM, halrow wrote:

    This is Halrow and with DRYS ..DRY SHIPS INC.

    you need to know the facts...Mr Economou has recently created over $1.5 billoion in retained cash going forward....DRYS has assets in plant and

    equipment of over $ 3 Billion...Mr Economou has purchased back in time 4 deep water drill rig platform s or islands worth $800 million each....Drys has a dbt load i see on record of $1.080 bil.DRYS

    is favored by Cantor Fitzgerald as the prime company to survive into the shipping BOOM to come...This may start by end of 09 but bigger growth in 2010.An anylyst on Bloomberg radio for the oil industry said

    a severe shortage of oil within 2 months will cause

    oil prices to soar to between $400 and $500 dollars

    a barral down the road...DRYS recent press

    release said DRYS was on target to Spin Off A

    new company from its OIL RIG business to

    shareholders on a one share for one share basis.,

    When DRYS spins off this special dividend and oil

    skyrockets to the hundredsper barral those oil rig shares could be astrnomical for current sharholders

    holding long....From what i am seeing now with the market turnaround and the Goverment buying up

    american assets ,with a possible 2 more trillion in stimulous on the way,,,the shippers will rise again

    along with commodities and huge world demand

    increase for OIL:....Alternative energy changes .will take to many years to reach any significance,leaving

    solar and wind and other sorces a not to relevant investment in these hard times..Oil will still be the main energy and it will soar beyond belief..MHOP

  • Report this Comment On March 19, 2009, at 12:08 PM, mjonesy1985 wrote:

    I bet everyone who talked badly of Dry Ships feels stupid now.

  • Report this Comment On May 16, 2009, at 7:29 PM, greenwave3 wrote:

    GXDX looks like a bona-fide monster going forward. Huge growth and it just hit a double bottom. See you at the top.

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