Published:
October 13, 2008
At one point or another, nearly all of us have received some type
of "hot" stock tip.
Maybe you have a tech-savvy friend working as a software
designer who is convinced his firm will soon be the next
Microsoft (Nasdaq: MSFT). Or possibly you overheard a co-worker who learned
from his uncle that a certain defense company has the inside
track to a plum government contract.
Typically, this friendly advice is best ignored. Even if the
companies involved really are poised to deliver some big news,
you can bet that the smart money was already made long before
the rumors filtered through the grapevine.
However, that doesn't mean there aren't ways of sniffing out big
stock moves before they happen. They key is to block out the
speculation and go right to the source -- a company's top
executives. If they are quietly scooping up shares hand over
fist, you can bet there's a pretty good reason.
More often that not, putting your money alongside theirs can be
a great way to gain a valuable edge over the market.
Follow the Right Footprints
To clear up any confusion, some insider
trading is illegal. Whenever an executive or anyone else in possession of material
information (the kind likely to have an impact on the stock's
price) acts to take advantage of the situation before it's made
known to the general public, they could find themselves in
serious trouble with the Securities and Exchange Commission
(SEC).
Fortunately, there are plenty of times when directors, officers
and other insiders are perfectly free to buy and sell shares
just like the rest of us. And thanks to the Sarbanes-Oxley Act,
all of these transactions must be reported within two business days. Of
course, these moves won't be widely advertised. So while
interested investors must do a little detective work, the extra
effort will often be rewarded many times over.
After all, nobody knows the inner workings of a company better
than its own leaders. At the same time, these experts are
acutely aware of current industry trends and where the business
is headed. They are also in constant communication with
suppliers and customers and will generally be in an advantageous
position to spot changes long before the average investor even
has a hint of what might be coming.
Of course, anyone who has spent much time
analyzing annual reports understands that all executives are
company cheerleaders that usually paint things in the most
favorable light possible. But when they put their money where their mouth is and buy the
shares for their own account, then that optimism is genuine --
actions always speak much louder than words.
Real Success Stories
Insider stock sales, however, may be
a less
reliable indicator than buys. Insiders often sell for any number
of reasons that have nothing to do with the company. But insiders usually buy for only one reason -- they expect the stock to
go up.
And there have been numerous studies to suggest that investors
might be wise to follow their lead. The most famous work was
conducted at the University of Michigan by Professor Nejat
Seyhun, who compiled data on over one million insider
transactions over a 21-year period. According to his findings,
stocks being aggressively bought by insiders tended to
outperform the market by a considerable +8.9% over the following
12 months.
Of course, that figure represents the broad performance of
thousands of stocks. Some undoubtedly saw narrower margins,
while many others went on to deliver massive triple-digit gains.
Consider Terra Industries (NYSE: TRA), a major supplier
of nitrogen products for fertilizer. At the beginning of 2007,
the agricultural boom that sent crop prices soaring was still on
the horizon. However, a number of Terra's insiders saw something
they liked.
On February 28, 2007, President and CEO Michael Bennett plunked down
$1.2 million to buy 69,000 shares at around $17.50 per share. At
the same time, eight other officers made sizeable purchases of
their own. A few months later (with the shares already having
risen to $26.35), those same officers all put in more money --
with most investing around $150,000 or more. And then on August
1, 2007, seven of Terra's directors decided to join in, scooping up
another 75,000 shares between them.
Investors that took notice of this bullish enthusiasm reaped
some nice returns. By January 2008, shares of TRA gained nearly +200% in less than a
year.
And as you can see from the chart below,
Michael Bennett and other
executives at Terra definitely knew what they were doing.
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This
is hardly an isolated example. Earlier this year, we saw a
similar pattern with direct marketer Systemax (NYSE: SYX).
Chairman/CEO Richard Leeds and several other insiders began
buying shares on March 13th at $11.45. Not coincidentally, that
marked the low point, and the stock began climbing almost
immediately after that. By May 13th, SYX was changing hands above
$20 per share -- a gain of more than +70% in just two months.
Reading the Tea Leaves
As you can see, it pays to keep a close eye on insider activity.
But some purchases send more powerful signals than others. With
that in mind, be sure to consider insider buying within the
larger context of the questions below.
Who's Behind the Buying?
-- It stands to reason that
commitments made by CEOs and CFOs that are actually in charge of
day-to-day operations will be more predictive than purchases
made by lower level officials and institutional owners.
Is there a Group Consensus? -- Is there just one buyer
at the table, or have a large number of insiders joined in? The
more people involved, the clearer the message. And because many
insiders like to bottom-fish, the signal is even stronger if
they are still buying even after a run-up in the shares.
How bold are the bets? -- For an executive with a
seven figure salary, a purchase of $2,000 really isn't saying
much. Now, if the latest acquisitions involve big dollars that
double his/her holdings, then there is a better chance of
something positive around the corner.
Is there a change in strategy? -- Check historical
trading activity over the past couple years. It could be that
the latest purchases are part of a regular pattern of buying
once per quarter, etc. A shift from net selling to net
purchasing or a sudden surge in interest at irregular intervals
may be more meaningful.
What size is the company? -- Insider trading can have
a bigger impact on smaller companies for several reasons. First,
there's the simple fact that small-cap stocks aren't as liquid
and an influx of buy orders on the open market can drive up
prices quickly. More importantly, they aren't as closely watched
by analysts, so bullish moves by top brass are more likely to
presage something unexpected that nobody sees coming.
Who's Buying Now?
Of course, knowing what to look for is one thing, but being able
to synthesize the mountain of available data into something
actionable is a different matter entirely. Every day, regulatory
databases record as many as 2,000 filings from over 300
different companies.
Fortunately,
Half-Priced Stocks newsletter editor Nathan
Slaughter has already done most of the heavy lifting for
you. He's put together a list of companies that qualify as
attractive insider trading candidates. Not only are these stocks
being aggressively purchased, but they are also all trading at
compelling discounts to fair value. If you'd like to learn more
about this fascinating list that Nathan has put together -- and
learn more about his Half-Priced Stocks newsletter,
please visit this link. |
