Here's something you don't see every day: Executives and directors of a publicly held company, exercising stock options and holding on to the stock.
OK, not all of the stock. But insiders at corporate used-car salesman CarMax (NYSE:KMX) are reportedly retaining a good chunk of the shares resulting from their exercised options -- and buying more stock on the open market to boot.
According to Yahoo! (NASDAQ:YHOO) Finance, in just the last couple of weeks, nine directors have each exercised options to buy about $10,000 apiece in CarMax stock at prices above Thursday's $19.38-a-share close and have not sold a single share. One of these directors even went out and bought himself another 25,000 shares on the open market. A CarMax officer cashed in a huge chunk of options but apparently used the proceeds from these sales to pay for 6,445 more option-exercised shares that he held on to. And an officer of a CarMax subsidiary did the same thing, winding up with 8,600 more option-exercised shares.
While there are many reasons why a company insider might want to sell his shares (to diversify his portfolio or make the down payment on a new McMansion, for example), there are only two major reasons for insider buying. The insider may be selflessly putting his own money on the line in a fit of "window dressing" -- making a brave show of confidence in his doomed company. Either that, or one of the guys who knows the business best thinks its shares are undervalued. Considering the scale of the insider purchases going on at CarMax, I am inclined to believe that we are seeing the latter here.
As to whether the insiders' faith in CarMax is justified, I suspect it is. Sure, when investing, I place great faith in a company's generation of free cash flow. And no, CarMax is not free cash-flow positive -- yet. But over CarMax's past two years as an independent company (Circuit City (NYSE:CC) divested CarMax in late 2002), its cash from operations has doubled year over year, while capital expenditures increased at only half that rate. That's the kind of trend that promises strong free cash flow in years to come.
Given the company's cash-flow trend and the insider purchases, investors may want to take a second look at this company. It's a bit of a gamble, but for investors with a long-term view, I suspect the odds are on their side on this one.
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
