Buying and Selling
Many research firms track insider
buying and selling, and claim it is a strong indicator of where the market
is headed. And Wall Street warms to insiders who like buying their own
stock, viewing it as a sign that management sees good things on the
But investors who believe they
can profit by mimicking insider buying sprees have had little opportunity
to do so. The latest statistics show that insider buying is the exception,
not the rule, with corporate insiders across the United States currently
steering clear of their own stock.
Insider buying fell to $149
million in March, down from $168 million in February. Experts say this
lack of buying is a strong bearish indicator.
Tracking of insiders' behavior
proved an excellent predictor of last year's stock market correction
because insiders, key corporate managers or executives who own 10 percent
of a company, are in the best position to know how their stock will fare.
In February 2000, insider
selling, a negative barometer, was at its greatest level ever, at $10.8
billion. Just a few weeks later, the technology-stock meltdown began, with
the Nasdaq composite index falling 33 percent from mid-March to mid-May.
Insider selling also picked up in August 2000, before the Nasdaq slid 20
percent in the following two months.
Experts were surprised insider
buying slowed in February and March of 2001, surmising that company
executives would have snapped up their own stock, available at deflated
Still, there is one sign the
broader stock market may have bottomed out, even though insider buying
continues to fall. The blistering pace at which insiders were dumping
their stock throughout 2000 has slowed to a trickle this year, with
selling declining from $4.4 billion in February to $2.2 billion in March.
While indicators such as these
are easier to chart for the wider market, it is much harder to use
insiders' behavior to predict how individual stocks will perform.
There is evidence to prove that investors
who acquire stock based on insider buying records earn higher returns than
those who do not. Nevertheless, investors who profit the most are those
who closely review the insider buying transactions.
Always checks to see who is doing the buying,
noting that the higher the rank of the insider, the better the indicator. For
example, chief executives are in a better position to judge a company's
prospects, knowing more about upcoming projects and long-term goals than, say,
But insiders do have to trade in accordance with
Securities and Exchange Commission rules, which state that executives can not
buy or sell shares based on proprietary or "inside" information.
Still, experts say insiders are rational investors who buy and sell based on the
financial condition of a company and its likely prospects.
Analysts recommend that investors follow the
success rate of insiders. For example, Wilfred Corrigan, chief executive of LSI
Logic, a circuit and storage network firm based in Milpitas, Calif., has a 100
percent hit rate: He has bought LSI stock 11 times and it has gone up 11 times
over the following six months.
But investors should not be fooled by insider
buying-which may be merely a PR stunt. If an insider buy is well publicized, in
a news release for example, it is likely to be done for the company's image.
Also, if an insider buys, say, 100,000 shares, but owns 10 million, it is not
terribly significant since that number comprises a small percentage of the
holder's overall portfolio.
Insider buying trends are easier to read for
small- to mid-size companies, which tend to offer insiders fewer, less
profitable, option incentives. Those at larger corporations are often awarded an
abundance of valuable stock options, which provide handsome gains on a small
percentage rise. Therefore, for insiders at large corporations there is less
incentive for buying. With smaller companies, insiders are typically not awarded
as many options and are forced to go into the open market if they want to share
in any future appreciation. On the flip side, insider sales are not always an
accurate measure that bad times are to come.
With the motive behind executive selling more of
a blur, investors need to tread carefully before jumping ship. For instance,
company executives may sell to diversify their portfolio, or to pay for a house
or a divorce. Many executives are paid in part by stock options, and exercise
them to get cash.
The insiders who are selling are aware that
everyone [Wall Street] is watching them and are hesitant about selling before
bad news arises. While insider sales should be looked at, they are only a small
piece of a lot of information. But much can be gained by reviewing insider
selling, if the data is carefully reviewed.
Investors need to be on the lookout for
behind-the-scenes moves as well. In some cases, insiders are able to protect the
value of their holdings by entering into option contracts with banks, experts
said. A chief executive could buy a put option from a bank, which would protect
the value of their holdings if they dropped below a certain price.
Therefore, if they were pessimistic about the
future, they could legally buy puts, according to the SEC. However, if they
bought puts with the knowledge of bad news to come they would be breaching
insider trading laws.
There are few insiders who have reported their
option transactions to the SEC, many insiders fail to report them and therefore
they do not get picked up on the selling radar screen. This is a violation of
Insiders have to be careful when buying options;
the first thing the SEC does when it believes illegal insider trading took place
is to look at whether the trader had owned options.
It appears it is beneficial to track insider
trading, but, as with anything else, it is not the key to financial success. It
is just another tool a smart investor can use.