I believe that is correct.
insidertrader.com
1/13/99
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James Cramer is WRONG!
A cohort recently brought to my attention one of the columns from
theStreet.com's well-known commentator cum portfolio manager, James
Cramer. It was entitled: "Don't Listen to the Insiders" and was published
sometime last December.
We have nothing against the man or the website, but I really must speak up
about his conclusion.
We don't know whether Mr. Cramer was merely venting frustration over a few
bad trades, or whether he had to meet a deadline and felt that some insiders
who so far have not made money with their trades were easy targets for his
widely read insights. But this column was hardly serious investment
commentary.
If James is disappointed that he can't simply follow insiders into the stocks
they buy and make money, so be it. But that is not a valid expectation to
have when using insider data in the investing process.
Like this Article?
Following insiders doesn't work all the time. Duh. What investment approach
does?
But just because some insiders have been wrong in the past (and some more,
no doubt, will be wrong in the future) doesn't make Form 4 filings not worth
following as Mr. Cramer sums up.
Follow Insiders--But Not Blindly
At InsiderTrader.com we have a more realistic approach to using this very
useful information stream. We believe insider data should be used primarily as
a first screen to determine what stocks to undertake further analysis on.
We do not particularly look forward to wading through a company's 10-Ks and
10-Qs, and it certainly doesn't improve our temper when we take the hours
necessary to analyze them only to conclude the company is a dog. Using a
decent insider profile as a first screen (found via our Weekly Insider
Summaries Sorted by Transaction Value, Interactive Special Screens, Daily
Screens, or Weekly Reviews) is a great way to ensure that we are rewarded
for our labor.
Like Mr. Cramer, we also have plenty to gripe about if we wanted to blame
insiders for leading us into losses. Sun Healthcare--yuck! SyQuest--gross!
But in the end we don't blame the insiders whose activity got us to look at
those companies, we blame our subsequent analysis. Mr. Cramer should as
well.
As long as we are mea culpa-ing, we have also lost money in REITs over the
past year following the insiders in that sector. We believed the double-digit
yields on many of these securities would hold up their prices. They didn't. But
the double-digit yields certainly mitigated the losses on these positions.
Insiders Tend To Be Early
Oil insiders looked as clueless as REIT insiders back in the Fall of 1998.
Nobody thinks these executives were wrong now. They were the main group
to foresee the wholesale turnaround in their sector's fortunes while many oil
analysts were wondering how they could possibly get transferred to the
high-tech beat. Even investors who got into oils early with the insiders back in
the Spring of 1998 have made money. We certainly did with Lone Star(Nyse:
LSS - Insiders, News, Boards) a 69% gainer in 7 months.
Insiders in other basic industries are also getting the last laugh over talking
heads who questioned their buying. Our recommendation of Wierton
Steel(Nyse: WS - Insiders, News, Boards) back in July 1998 looked like a
terrible loser for most of the time we have followed it in our online Newsletter.
The extent of dumping by foreign steel producers in U.S. markets caught us
(and obviously the insiders we followed) by surprise, and this position sank
along with its peers.
We were even more surprised by the reaction of Wierton's stock, which at one
point halved from where we bought it (an occurrence which prompted us to set
stop losses for our recommendations). It was clear to us, though, that the
sell-off of Wierton was overdone given the different initiatives it was
undertaking. We stuck with it, and we now have a 151% gain in this position.
Were insiders wrong or early at this company? Early, just as academic
research indicates they tend to be.
Were we fools to hold onto Wierton for so long? Was the dead money we held
for over a year worth the more than 150% gain we have today? We think so.
Sure it would have been nice to buy the stock just before it popped, but we
are smart enough to know that you can't always be smart enough to know
precisely when something is about to move.
This may make the eyes roll from someone judged mercilessly by quarterly
performance, but most individual investors (even in this day-trading age) have
a longer investment horizon that that.
More Winners Than Losers
SonoSite(Nasdaq: SONO - Insiders, News, Boards) likewise went down
during the first month we recommended it, but soon took off. When insiders
averaged up in the stock, we pounded the table again. SONO is now a more
than 376% gainer for us, and we still rate it a buy and are churning out more
research on it via our Newsletter.
When Callaway Golf(Nyse: ELY - Insiders, News, Boards)had massive
insider buying after it first tanked in July 1998, we didn't jump on it
immediately. Our analysis showed that management still had some fan
cleaning to do. We finally recommended it nearly 8 months after the insider
buying that originally caught our attention. As it turns out, the stock popped a
month later.
The important point is we didn't recommend ELY because insiders bought it,
we recommended it because we expected good things from the company's
reorganization and an eventual return of demand from Asia. ELY first came to
our attention because of its insider trading, but when we finally bought it was
for its fundamentals. The same for Concord Camera (Nasdaq:LENS -
Insiders, News, Boards), Ventana Medical(Nasdaq: VMSI - Insiders,
News, Boards) Pilgrim America Capital Corp. (acquired), and all the other
stocks we've recommended.
Insiders are not geniuses, but academic studies have shown that stocks
with insider buying tend to outperform the averages. We are also not
geniuses, but we have been right more than wrong following the
insiders, and our winners have gone up more than our losers have
gone down. That is what realistic investors should expect of any
investment approach--insiders included.
Further supporting the use of insider data in your research process is the fact
that many of our winners began as value plays--an approach that has been
horribly out of favor for years. For us to find winning small-cap value plays in
this market is not so shabby.
No, insiders would not have gotten you into Internet stocks. But let's face it,
neither would any reasonable fundamental analysis. This hardly means
following the insiders always dredges up boring value stocks (even though
academic studies show that insiders do tend to be value players). We love
screening for stocks that have decent insider buying and are also trading well
above their 52-week lows. This screen is actually presented every Monday in
our free Daily Screens section.
Again, don't throw money at a stock just because it makes one of our Daily
Screens. Use the Tips provided on the site to investigate the list further to see
if more fundamental analysis is worthwhile. In the case of this Monday
screen, find the stocks on the list with strong price momentum and insiders
averaging up.
Something For Every One
In fact, our Daily Screens are a good example of how insider data can be
used by investors no matter what style they have. Read the descriptions on
the Daily Screens page, we have screens for momentum, value, income, and
short selling. If you subscribe and use our Interactive Special Screens , you
can run with the basic criteria we suggest on the Daily Screens and tailor
searches for your personal needs.
We like Mr. Cramer, and respect that he comes out and tells people about his
mistakes in order for others to learn from them. Many investment
professionals think they must put on a façade of perfection to be taken
seriously. We agree with Mr. Cramer that this is unrealistic.
But jeez, it's OK to admit that even good craftsman can use insider data
incorrectly without blaming the tools themselves. Sure, stocks first come to
our attention via their insider trading, but we buy them because of their
fundamentals.
So should you.
PostScript
Mr. Cramer's column is hardly the first to "diss" insider trading data as useful.
Journalists seem to enjoy pointing out when executives lose money on their
trades. Pointing out when executives make money with their insider trades
seems reserved for when a journalist deems the profits to be unfairly made.
Another way the legal insider trades filed at the SEC are misrepresented in
the press is that journalists seem to love pointing out when insiders have sold
before their stock plunges. This may be interesting to investigative reporters
looking for a conspiracy, and class-action lawyers looking for business, but
investors require foresight to make money, not hindsight. And the lesson that
such articles imply--that insider selling is a reliable harbinger of bad things--is
false.
It is more difficult to divine useful information from insider selling than insider
buying. The simple reason for this is that there are just too many legitimate
reasons for insiders to sell. They may need money to buy a new car or house,
or to send a kid to college. For some founding executives, the stock holdings
in the company they helped build may represent the vast majority of their net
worth. In these cases it's just prudent for them to diversify assets. And who
can blame Internet execs for exercising options for $1 and selling the stock
immediately for an immense risk-free gain. This is just found money to them!
Most professional investors, having used insider data for years or decades,
know the basics of using insider data in the investment process. But now that
the data has entered the public domain (led, by the way, by InsiderTrader.com
in June 1996), it's a shame that journalists confuse individuals about its
usefullness.
We are hoping to clear some of this fog with our book, which is due out this
Summer from Dearborn Press. It's entitled, quite predictably enough: Profit
from legal Insider Trading.
All the best!
Jonathan Moreland |
