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At an investment conference last year, an attendee told me he was shocked by the level of insider selling in some of his stocks.
Should he sell? Not necessarily.
There are plenty of reasons that officers or directors might sell that have nothing to do with the outlook for their business.
For example, insiders might sell to diversify their portfolios.
Bill Gates has been a regular seller of Microsoft (Nasdaq: MSFT) for decades, even though it has gone up severalfold.
Is it because he doesn’t like the outlook for the company he founded?
No. It’s because the overwhelming majority of his multibillion-dollar net worth is tied up in the stock.
Even Bill Gates has an overhead. That means he must sell shares from time to time.
Or… an insider might sell to meet a specific financial need like buying a second home or paying Ivy League tuition for his kids or grandkids.
Maybe he’s getting a divorce and has to sell half his shares.
There are plenty of reasons an insider might sell that have nothing to do with the near-term prospects of the business.
Of course, there are good reasons an insider would sell that have everything to do with the company’s near-term prospects.
The insiders at Enron, for example, sold $1.1 billion worth of the stock in the 12 months before the company filed bankruptcy.
Insider selling is tricky. Sometimes it’s a negative signal. Other times it’s neutral.
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, they feel the shares are selling far below their intrinsic worth.
Insiders have an unfair advantage. They have access to all sorts of material, nonpublic information, including…
- The direction of sales since the last quarterly report
- Any new expansion plans
- Whether the company has gained or lost any key customers
- New products and services in development
- The status of litigation against the firm
- Whether there is any takeover interest
… And plenty of other relevant information that is unavailable to those of us on the outside looking in.
That’s why the SEC requires corporate insiders – the officers and directors who oversee a company – to file a Form 4 within two business days of any purchase or sale, detailing the number of shares transacted, when and at what price.
That helps level the playing field.
You may not know why a particular insider is buying. But at least you know that he or she is.
Even when corporate fundamentals are checkered or poor, if the insiders are buying heavily, it is generally a sign that the company is undervalued relative to its future prospects.
Indeed, plenty of academic studies have confirmed that stocks with heavy insider buying tend to outperform the broad market in the months that follow.
Nobody beats the market by outguessing it. (Trying to be in for the rallies and out for the corrections.)
Market timing is a mug’s game. You beat the market by owning stocks that outperform it.
But to do that, you need an edge. Insiders have the biggest.
There are lots of reasons to buy a stock: product innovation, market share, sales and earnings growth, operating and profit margins, price-to-book value, dividend yield, etc.
But all of these are well understood by corporate officers and directors – and reflected in their decisions to purchase the stock.
Insider buying isn’t just valuable information. It’s the best buy signal you can get.
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