We recently wrote about why insider buying matters more than insider selling, and the distinction is important. Insider selling may garner some attention, but it’s not a meaningful investing signal. Executives and directors sell stock for all kinds of personal reasons that may have nothing to do with the company itself. They may be diversifying, paying taxes, funding a major purchase or raising cash for family needs. And as stock-based compensation continues to rise, this is unlikely to change anytime soon.
Insider buying is different. When an executive or director buys shares in the open market with personal money, that decision is usually much more direct. They are choosing to increase their exposure to the company at the current price.
But even with buying, it’s important to distinguish between what real insiders are doing and what’s being reported simply because it has to be.
In Cabot Insider Edge, Chief Analyst Michael Brush notes that he excludes “investors considered insiders because they hold big positions (beneficial owners). This is because around 80% of investors typically lag the market.”
In other words, beneficial owners may own a large enough stake that they have to report transactions to the SEC, but they do not necessarily have the same day-to-day view of the business as executives and directors; it basically makes them glorified retail investors. As a result, their purchases are not the same kind of “signal enhancer” as open-market buying by a CEO, CFO, director or other actual insider.
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That distinction is critical. The best insider-buying signals usually come from people who are close enough to the business to have meaningful insight into operations, demand, margins, competitive conditions and strategy.
Once you’ve identified what the real insiders are doing, start applying Michael’s signal enhancers to your analysis. Here are three rules for doing just that, in Michael’s words:
3 Rules for Following Company Insiders
1. Ignore Insider Selling
Insider selling is rarely a great signal, since insiders can sell for any number of reasons that have little to do with their company outlooks. Maybe they need to raise cash to pay for a child’s education, for example.
2. Watch Insider Buying Clusters
Insider buying can offer great insights into where stocks are headed next – especially when the insider buying signal is enhanced by certain patterns. For example, I like to look for cluster buys by several insiders at once.
3. Pay Attention to Size
It also pays to follow what I call “size buys” worth $500,000 or more.
After I identify enhanced signals like these (and several others), the next step is to drill down on company and sector trends to see if it makes sense to follow the insider.
Of course, it’s worth noting that insider buying alone isn’t enough to justify taking a position in a stock. You’ve also got to consider the prospects of the company itself.
That said, if company executives think a stock is undervalued enough to step into the market and buy, then it’s worth paying attention.
And if you’re interested in learning more about the companies that Michael Brush is recommending in Cabot Insider Edge, subscribe today. We’ve got a promotional offer for new subscribers running right now.
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