By Alison Rice. Six months ago, builders were the darlings of Wall Street. While other industries stumbled, builders produced record profits in the downturn, attracting attention--and investment--as valuations for their frequently overlooked stocks rose.
But now last spring's high stock prices have produced something not so pleasant: an increased scrutiny of stock sales by executives of these same builders, which reached unusually high levels this year.
How high? Try $318 million in total stock sales between April and June.
Normally, the 16 public builders with insider selling during that time average a net of $5.19 million in such sales, according to Brick Securities Washington Service, a research firm in Washington. But that figure jumped to $20 million for April through June.
Investors often view such activity with concern, wondering what might be going on that they don't know about. "Selling isn't as transparent, whereas buying is always seen as a good thing" because it expresses confidence in a company's prospects, explains Kevin Schwenger, a research analyst at Thomson Financial.
Research suggests such skepticism might be well-placed. According to Steven Huddart, an associate professor of accounting at Pennsylvania State University, insider selling often precedes an "earnings break"--a dip in year-over-year quarterly earnings--by nine months to two years.
The news of the unusually large sell-off has people spooked. According to an August 29 article in the Financial Times, such activity suggests that home building executives "believe the country's housing market has peaked." But analysts strongly disagree with that interpretation. "The Financial Times article distorted the facts," says UBS Warburg analyst John Stanley. "I don't have any problems with these guys selling some stock since they all still own large positions and are creating a lot of shareholder value."
Stanley discounts the idea that inside selling suggests a future "earnings break." "I honestly do not believe most managers have any better sense of what is going to happen to quarterly earnings three to eight quarters [in the future] than a coin toss," he says. "Home builders may be an exception given their long backlogs, but all the inputs they are getting today say earnings will be accelerating over the next several quarters."
Ivy Zelman of Credit Suisse First Boston also says the negativity is being overdone. She sees the situation as routine profit-taking during a period in which builder stocks were trading at 10 times earnings, not a sell-off while the stocks were sliding. Selling at high valuations represents a mitigating factor to researcher Huddart as well. "If stocks are high relative to historical levels," he says, "insiders, like everybody else, want to get out when prices are good."
And insider ownership remains high in home building, compared with other industries. "These guys own 22 percent of the outstanding shares," says Zelman, who adds that builders' real ownership interests may be even higher, given that insider figures don't include unvested stock or options.
Insider trading data has other limitations as well. While it notes whether a transaction was option-related, it doesn't always list stock purchased by exercising options. For example, a builder may be selling 10,000 shares at $50 each, but only after exercising an option to buy them at a strike price of $10 per share.
That's more bearish than exercising an option and holding the stock, but that second, more bullish choice isn't always financially practical, according to Andrew Parnes, CFO of Standard Pacific Corp. The Irvine, Calif.-based company was one of the few public builders with no insider selling during the quarter, thanks to an equity offering and pending acquisitions.
"It's very difficult to exercise and hold because it takes a lot of cash," says Parnes, who adds that executives often sell some stock to cover the cost of exercising options. "It doesn't mean you think you're at the top."