When management thinks like shareholders

5iResearch securities analyst Moez Mahraz finds companies with high insider ownership do well. When management has significant “skin-in-the-game”, their interests are closely aligned with yours.

Many of the companies we follow have high insider ownership. Of course, we like this attribute when it shows up along with other factors such as good management, a good track record of growing dividends, buying back shares, and a healthy balance sheet.

As a small shareholder, you’ll effectively have a seat at the board table in companies with high insider ownership.

The appeal behind high insider ownership comes from the idea that insiders at a company—whether they are management, employees, executives, founders or even corporations—have more at stake. Because of this there is, in theory, a higher motivation for insiders of a company to perform well. This, ultimately, is positive for all shareholders alike.

Individual and corporate ownership

In our view, insider ownership is not just limited to individuals. We often find that corporations control a big portion of insider ownership as well. Individual and corporate ownership are very different types of ownership, as institutional investors have much less to lose from the failure of one company. That’s due to the diversified nature of their investments.

Individual and corporate investors however, have more skin in the game, and for strategic reasons. Corporate investors in particular tend to have very concentrated positions and are often either companies that own a big stake as a strategic interest, a parent company or a corporation owned by the founder of the company.

Investors will recognize many names in this category such as Loblaw Companies Limited, Great-West Lifeco Inc., Imperial Oil Limited, Husky Energy Inc. and Hydro One Limited. High insider ownership by mostly individuals usually consists of either a few individuals (executives or owners) that own say, at least one per cent each, or many employees and executives that collectively own a decent portion (say five per cent) of the company. Both are nice to see, but have different implications.

‘Skin-in-the-game’ makes for motivated executives

A few individuals owning a significant amount of shares of the company means more skin in the game for a few highly motivated executives or owners and a desire to improve the profitability of the company. Examples of this in our screen include companies like George Weston Limited and Maple Leaf Foods Inc. with a single individual holding 52.6 per cent and 39 per cent, respectively.

That sort of heavy ownership implies a great deal of control of decision-making by one shareholder and is a different dynamic than the one at play in companies like Onex Corporation, Northland Power Inc., SmartCentres Real Estate Investment Trust, Empire Company Limited, FirstService Corporation and Kirkland Lake Gold Ltd. which have 7-15 per cent ownership by at least one individual shareholder. Although still considered significant ownership, it is also low enough to keep these shareholders in check with regards to looking out for the interest of other shareholders and maintaining a more ‘democratic’ approach to company decisions rather than a pure exercise of power.

We find companies in this category interesting because the power dynamics create a set up in which a few individuals are highly motivated to profit from the company’s success while making sure shareholders are satisfied.

Small insider groups act like a team

There are other companies that have a small to large group of employees and executives owning a sizable portion as a collective. This is another notable group of insider ownership stocks that we think deserves some attention because a company run by a group of motivated individuals can have significant, positive effects on operations.

Some examples are familiar names like Brookfield Asset Management Inc. which has four individuals each holding a share of >1 per cent totaling ~8 per cent; Premium Brands Holdings Corporation with a larger group of employees collectively owning a total of four per cent; and Spin Master Corp which has ~2.5 per cent with one individual and ~3 per cent among other executives and employees.

Return on equity (ROE) and insider ownership

One way to measure whether high insider ownership has positive effects on a company’s operations is to look at a measure like ROE, which attempts to measure management effectiveness. This is by no means a silver bullet to interpreting the correlation between insider ownership and company operations but we think it provides some support for a good overall investment thesis.

Although not all companies with high insider ownership have high ROEs, many of them do. Notably Onex, Northland Power, FirstService and Colliers International Group show twelve-month trailing ROEs of 68.2 per cent, 36.8 per cent, 28.8 per cent and 26.3 per cent respectively, making them definitely worth a closer look.

We also observe that many companies with high corporate insider ownership (as discussed above) have very low ROEs, like Choice Properties and Cenovus Energy. We see higher ROEs in companies with higher individual insider ownership, which attests to the idea that having more skin in the game from individuals can lead to better results.

Closing thoughts

Companies with high insider ownership have proven to do well in many instances, which is why we thought screening for them would give us an interesting group of companies into which we could dive deeper. Although it is reflected as a percentage, the analysis of insider ownership is more qualitative and even subjective to a certain extent.

We think it is worth giving attention to and helpful in assessing motivation within the corporate structure. That said, we do not think it should form the basis of an investment thesis, rather it compliments other metrics and fundamentals nicely, provided they are there in the first place.

Moez Mahraz is an analyst at 5iResearch. Analysts at 5iResearch cannot trade Canadian stocks.

This is an edited version of an article that was originally published for subscribers in the August 2019/First, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

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