A subscriber recently wrote to tell me that he was alarmed by the amount of insider selling in some of the stocks he owned.
Should he sell? Not necessarily.
There are reasons that officers or directors might sell shares that have nothing to do with the outlook for the business.
For example, they might be trying to diversify their portfolios.
Many executives have most of their net worth tied up in their own stock.
Bill Gates, for example, has been a regular seller of Microsoft (Nasdaq: MSFT) for decades. Is it because he didn’t like the outlook for the software industry or the company he founded?
A large percentage of his multibillion-dollar fortune is still in the stock. It makes sense to spread his risk among other assets.
He still owns more than $23 billion worth of Microsoft, however.
Plus, insiders – like the rest of us – have an overhead. They may have to sell shares from time to time to meet expenses.
They might be buying a second home or paying Ivy League tuition for their kids or grandkids.
Or maybe they are getting a divorce and have to sell half their shares.
There are plenty of reasons an insider might sell that have little or nothing to do with the health or prospects of the business.
On the other hand, there may be excellent reasons an insider would sell that have everything to do with the company’s near-term prospects.
The insiders at Enron, to give one significant example, sold $1.1 billion worth of the stock in the 12 months before the company filed for bankruptcy.
In short, insider selling can be tricky. Sometimes it’s a negative signal. Other times it’s not.
But turn the equation around.
Why would insiders buy significant amounts of their own companies’ stock with their own money at current market prices?
There is only one logical answer.
Given all they know about the company – including plenty of material, nonpublic information – they feel the shares are selling for a lot less than what they are worth.
Remember, corporate insiders know things like…
- The direction of sales since the last quarterly report
- Any expansion plans (or potential mergers and acquisitions)
- Whether the company has gained or lost any key customers
- New products in development
- Whether there is any takeover interest
- The status of pending litigation
- Plenty of other important information unavailable to those of us on the outside looking in.
That’s why the SEC requires corporate insiders – officers, directors and beneficial owners – to file a Form 4 within two business days of any purchase or sale, detailing the number of shares bought, when, at what price, and so on.
To buy stocks that they are bailing out of or sell stocks that they are eagerly buying can be a fundamental mistake.
Even when recent developments at the company are worse than expected, if the insiders are buying heavily it is generally a sign that the company’s prospects are about to change.
And the stock is likely to head higher.
Indeed, plenty of academic studies have confirmed that stocks with heavy insider buying tend to outperform the broad market in the months that follow.
Do you know which stocks the insiders are piling into right now? You should.
Right now I’m finding that insiders are buying a surprising mix of brick-and-mortar retailers, technology leaders, biotechs, financial firms and disruptive companies.
Many of these stocks will be future market leaders.
No market signal is infallible, of course. But insiders clearly have an unfair advantage.
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