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Insiders/Management Buying and Selling?

Directors Buying or Selling
Written by Andy

When insiders buy should investors follow them!? What does it mean if insiders/management are buying? And what if directors are offloading stock? Has anyone seen any good recent studies of share price returns after insider/management buying and selling? Buying or selling of shares by a company’s directors can be a good clue for investors. But you need to know how to interpret their dealings. From my experience management buying shares has not been a reliable signal, but management dumping shares is an incredibly good sell signal.

Insiders sometimes attempt to “signal” the market with their purchases.  Beyond “signaling” the market, insiders are sometimes narrowly focused on their companies and might not see the big picture macro changes that the market might perceive before them.  So while the business might be doing great, the sector might be at a cyclical peak or the macroeconomic environment might point to problems ahead.  Insiders could also be anchored to old prices and just like value investors, might think that lower prices mean they should add to their investment. The old “how can it go any lower”, right before it does.

Insiders are often early and while the thesis might play out, it may take several months. Everyone has different time horizons and while the insider might be thinking about business performance a year out, an investor that follows the insider might give up six months in.  Given all these conscious and subconscious biases, are there ways investors could benefit from following insiders?

It is well established that most of the signal in insider transactions comes from insider purchases and not from sales. Insider ‘sells’ can be made for personal reasons rather than concerns for the company’s prospects. For instance, a director may simply be buying a house. As Peter Lynch explained in One Up on Wall Street: ‘Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.’

It helps to pay attention to what insiders of multiple companies in the same industry are doing. Are the insiders of both Six Flags $SIX and Cedar Fair $FUN buying stock at the same time?  Are the insiders of regional banks $ZION and $HBAN buying shares at the same time like they did recently?

Dumping is generally a more reliable signal… Sometimes though insiders may be #selling for a number of reasons other than potential underperformance: to diversify their portfolios, raise cash for expenses, etc. Dumping (huge sells) with many doing it is always bearish.

But when insiders truly LOAD – it is definitely a good signal guarantee (not, but historically solid).  A cluster of insider purchases by multiple insiders of the same company could also be a positive signal as long as the purchases are not part of a secondary offering.  Are the CEO and CFO buying at the same time like they did at Warner Bros. Discovery $WBD recently?  Is an independent director of the company buying shares and do they also happen to be an investment professional with a good grasp of not just the company but also how to value a company?  A good example was Bruce Sachs’ purchase of Vertex Pharmaceuticals $VRTX in August 2021.  The length of time an independent director has been involved with a company can also make a difference. For example Mr. Sachs has served on Vertex’s $VRTX board since 1998.  Similarly Jay Hoag has been on Netflix’s $NFLX board since 1999.  Openinsider has a great chart that tracks this. The insider sell spikes also seem to correlate to local tops.

“Consistent with prior literature findings that insider purchases are more informative than sales (sales can be made simply for diversification purposes), the return difference was more pronounced for insider purchases than for insider sales.”

The reverse is the case. Insiders might be selling for a number of reasons other than potential underperformance: to diversify their portfolios, raise cash for expenses, etc. People have sold because they were getting a divorce. But you only buy with your own cash if you’re greedy and believe the stock will go up. The insiders already have a ton of shares. Why buy more?

Management buying shares could simply be exercising option rights. They often get these for free or cheap so when they are allowed to exercise, they do. Often followed by a period where they are not allowed to sell (lock up). Therefore, not a particularly good indicator if you ask me.

Also, how far into the future do you look to see if the buy was a success? The insiders have to hold at least 6 months. That being said, if a stock is down 60% this year, has negative earnings, and the only insider buying is the CEO, I would be leery. Where’s everyone else?

I also like to pay attention to the Chair of the Board, especially if they are an Executive Chair in a cyclical business and have observed how the business performs across multiple cycles.  For example, Germán Larrea Mota-Velasco’s purchases of Southern Copper $SCCO in 2015 were spot-on.  Founders at the helm that are buying shares are also interesting, although the recent performance of companies like Asana $ASAN with the billions of dollars of purchases by @moskov seem to indicate otherwise.  For example, Joe Kiani’s purchases of medical devices company Masimo $MASI nearly a decade ago were spot-on. For a more recent example, CEO Tim Chen’s purchases of Nerdwallet $NERD look interesting.

To summarize, each of the following types of purchases help:

  1. Multiple companies in the same industry
  2. Cluster buying within a company.
  3. Long-serving independent directors
  4. Chair of the Board that has seen multiple cycles
  5. Founders

Focus on larger trades in small value stocks. Research by Lakonishok and Lee scrutinised one million director trades in the period 1975 to 2005. They found that the highest returns were produced when at least three different insiders were trading sizable amounts of a small value stock.

Don’t get blindly sucked in. I tend to be careful of CEO’s who buy their company’s stock. It’s just bad practice to put all your eggs in one basket and some CEO’s will buy own stock just to try and fake that they have confidence in the company.

One of the most important patterns in director dealings is cluster buying, or those periods when several directors are snapping up stock at the same time. Act on buy signals as quickly as possible It pays to act quickly after the information is released to the market. Research suggests that while insider trades have been shown to be profitable signals for the first nine months after they are disclosed, on average about half of the profits are made within the first 60 days.

My rule of thumb is that management buying a rising stock is bullish but buying a falling stock is a non-event. Management selling a rising stock is acceptable, management selling a falling stock is super bearish. So basically look for buyers at the top, sellers at the bottom.

But at the end of the day, insider transactions are an idea discovery tool and cannot replace deep research needed to understand the company and the investment opportunity.  I use it as one data point in my research and for the most part appreciate its ability to serve up companies I might have otherwise missed.

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