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What insider buying at tech companies says about stocks and the economy

Unusually strong buying activity tells investors their fears are overblown, writes Michael Brush. Read More...

Insiders at tech companies are telling us our worries about the market are overblown. While experts debate whether trade wars and an inverted yield curve portend the demise of the U.S. economic expansion, this group of elite business leaders has little doubt.

Over the past few weeks, insiders at more than a dozen tech firms have purchased significant amounts of their company stock. Insider buying in the tech sector is highly unusual, so the purchases stand out.  

Buying has been especially pronounced at chip companies, which are particularly sensitive to China trade war saber-rattling and changes in growth prospects. The tech sector overall is among the most economically sensitive — so purchasing by those with the front row seats is particularly meaningful.

Studies by University of Michigan Ross School of Business professor Nejat Seyhun, market researcher Carr Bettis, and the research firms Market Profile Theorem and Vickers Insider Weekly have consistently shown that buying by corporate insiders often precedes bullish moves in stocks, sectors, and the market overall.

This is why insider buying is the starting point for stock selection in my stock newsletter Brush Up on Stocks, where I’ve recommended Cognizant Technology Solutions CTSH, -1.74% and Cree CREE, -1.13% in part on the basis of recent insider buying.

Stimulus to the rescue

The recent tech sector insider buying confirms a contrarian theory which holds that there’s more than enough economic stimulus in the pipeline to shore up the current economic soft patch.

The stimulus few people are talking about? Leuthold Group chief investment strategist James Paulsen cites the downward shift in the yield curve. This is different from the yield curve inversion, because it makes investment funding cheaper across the board. He also cites an increase in the money supply; the decline in commodity prices and increased government spending as major components of economic stimulus in the pipeline. Stimulus like this takes about six to eight months to kick in. So the timing here suggests an improvement in economic data by August or September.

“Current widespread worries about recession risk, weak economic growth, and disappointing earnings results could ease substantially by late summer or early fall,” says Paulsen. He’s particularly bullish on tech — a view confirmed by the recent spate of tech insider buying.”If the bull market continues tech is going to lead,” says Paulsen.

Read:   Why the next bear market could shave 35% off the Dow

If insiders and Paulsen are right, it makes sense to stay in stocks and increase exposure to economically sensitive areas like tech — or to the market overall via the S&P 500 SPX, +0.30%   or the Nasdaq COMP, +0.42%  .

If you want individual stocks, here are several tech names and sectors where insiders have been buying recently:

Software

Since the late 1990s, when Cognizant Technology Solutions first came on my radar as an investor, it has been one of the faster-growth software and IT services consulting players around. So its stock fell hard in early May on signs that the rapid growth is slowing down. Part of this is the law of large numbers: High-growth companies can’t keep up the pace forever, otherwise they would take over their entire sector.

Weak spending trends among clients in financial services and healthcare also hurt Cognizant, because the company generates 65% of its revenue from these two areas. Yet CEO Brian Humphries bought a lot of Cognizant stock in the weakness, which tells me the selloff is overdone, making Cognizant a buy at current prices.

His purchases make sense, since much of the financial services and healthcare weakness happened because certain customers merged. This reduces the overall spend on Cognizant services by the surviving company. Cognizant also is investing to expand its reach in hot areas of tech including cloud computing, automation, analytics, the Internet of Things, and social media.

Another avenue for growth: Cognizant receives about 77% of its revenue from North America, so it is relatively immune to trade wars. But this also implies plenty of room for growth abroad, and the company is going for it. Cognizant is investing to expand into Latin America and Europe. “There’s a huge opportunity outside of North America with our global growth markets currently accounting for just over one fourth of our total revenues,” Humphries said on the company’s May earnings call. Cognizant has a strong reputation among customers, and this will help it expand abroad.

Elsewhere in software, significant insider buying shows up at Anaplan PLAN, +0.75%  , a cloud company that helps employees across corporate divisions collaborate, share data, and make decisions with its “connected planning” software. Sales grew 47% in the first quarter, compared to the year before, and its customer base grew 43%. “Our platform is quickly becoming the new core digital technology standard that can dramatically improve the economics of any business, and our results reflect it,” said CEO Frank Calderoni on the company’s earnings call.

Chips

New managers at Cree are transforming this company by ramping up a higher-margin, high-growth specialized chip business. In semiconductors, Cree’s Wolfspeed division makes chips out of silicon carbide, which means they can manage high-voltage power distribution without overheating, notes Eric Marshall, a portfolio manager at Hodges Capital Management.

This is important for electric vehicles (EV), a robust end market for Cree. Cree’s chips also allow EV owners to stretch the mileage that they get out of a charge. Wolfspeed revenue has been ramping sharply for three years, and advanced 40% in the most recent quarter compared to the year before.

The company also makes chips out of gallium nitride for use in wireless communications. Chips made from this material provide wider bandwidth more efficiently. This makes Cree a play on the build-out of faster 5G networks. “The rollouts of these new networks is very, very high and we’re really struggling to keep up with demand,” noted Cree CEO Gregg Lowe.

Cree shares have weakened recently as the company guided expectations down to slower growth, caused by the end of some EV incentives in China. But the long-term trends behind the use of battery power in cars, trucks, buses, and forklifts are still in place.

“People see Cree as a way to play the long-term secular trends in electric vehicles and other things that use high voltage battery technology,” Marshall said. Cree has more than doubled its manufacturing capacity in silicon carbide chips, so it is ready.

Lowe cautions investors not to focus too much on the roll off of EV incentives in China. “The trend for electric vehicles in China, I think, is going to be non-stoppable. The country is moving very, very quickly to try to drive more adoption of electric vehicles,” Lowe said. One example: The country requires larger cities to convert buses to non-combustion engines by 2022.

Lattice Semiconductor

Lattice Semiconductor LSCC, +1.50%  specializes in field programmable gate array (FPGA) chips. They’re small. They don’t consume much power. And customers can easily put code on them that tells them what they do. All these features make FPGA chips suitable in rapid-growth areas such as data centers, 5G infrastructure, artificial intelligence, mobile devices, cars that are using more and more sensors, and the “Internet of Things.”

Lattice CEO Jim Anderson cites 5G infrastructure buildout as a key growth driver in the second half of 2019 and beyond. “This is really a good multiyear growth factor for the company,” he said in the most recent conference call.

Exposure to these high-growth end markets is one of the chief reasons Lattice is a favorite of John Krause, a senior equity research analyst at Thrivent Financial. “We saw an opportunity here as they changed management and became more focused on FPGA products,” Krause said.

Behind the scenes, Lattice has been cutting costs and adjusting prices upwards to improve margins. The company’s products are relatively cheap and make up a small portion of the overall cost of end products, so it is easier to pass higher costs on to customers, Krause notes. Lattice also has minimal exposure to Huawei Technologies , so it’s not caught up in that end of the China trade war, he adds.

In the chip space, there was also meaningful insider buying recently at Kulicke & Soffa Industries KLIC, +1.48%  , Macom Technology Solutions MTSI, -3.61%  , and Mellanox Technologies MLNX, -0.15%  . This particular insider buying has to be a play on NVIDIA NVDA, +0.16%   which is acquiring Mellanox. Among small-cap stocks, insiders were actively buying shares of optical components company NeoPhotonics NPTN, -1.87%  . That stock just got hammered because of its large exposure to Huawei, the Chinese tech giant President Donald Trump wants U.S. companies to avoid. Insiders seem to be saying that selling in NeoPhotonics is overdone.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested CTSH and CREE  in his stock newsletter .

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