SMARTMONEY.COM: Follow The Insiders
By CINTRA SCOTT
(This report was originally published late Thursday.)
NEW YORK -- Legal insider trading is hardly the stuff of sensational tabloid stories or Hollywood films. But if you know what to look for, following those plain-vanilla insider trades can help your portfolio.
The theory is simple. Insider buying is generally a bullish sign, and insider selling is generally (but less reliably) a bearish sign for a stock. After all, insiders have an inside view and, presumably, they aren't going to knowingly do anything to compromise their own profits.
To create an insider-buying screen, we called on Lon Gerber, director of insider research for Thomson Financial/Lancer Analytics, to show us how best to put insider knowledge to work. He advised us to look at a company's past transaction patterns and an insider's rank and purchase record. In other words, we want to find unusually heavy buying by those really in the know (see recipe for details).
The list we generated is a good place to start looking for investment opportunities, but beware of the risks. Insider buying is no guarantee a stock will rise - sometimes company executives and board members are drinking too much of the office Kool Aid, as the saying goes. It's also true that few of the companies on the list lack earnings (ahem, Corvis (CORV) and XO Communications (XOXO)) and we've all seen how the market treats losses these days.
We offer a couple of ways to check credibility. On each company's Investor Snapshot, SmartMoney.com rates the value of its insider insights by comparing insider returns to randomly timed trades. The top grade, A, means there would be no more than a 5% chance of exceeding the insiders return with random buying and selling. We also look to InsiderSCORES.com, which rates the individual inside investors. It looks for consistency and overall returns in either buying or selling to rank each insider one to 100 in both buying and selling. One hundred is the top score.
Gerber maintains that insiders tend to be value investors. The most successful ones, anyway. That's because they can't buy right before a big jump (or sell before a steep fall) without attracting unwanted scrutiny. You see, insider trading is illegal when it's based on "material" information that hasn't yet been released to the public. (For instance, the New York Times reported last month that the SEC is looking into selling by Jeff Bezos of Amazon (AMZN) right before a report was released doubting Amazon's financial viability.)
Instead of behaving like day traders, successful inside investors buy when their companies' stocks have attractive valuations, due to external conditions. Then they hold on, waiting for a rebound they're confident (based on their own assessment of the company's outlook) will come. "If they've been around long enough, they know how the cycles go and which time of year the stock tends to be cheap," Gerber explains.
Technology
It was with trepidation, however, that we looked at the tech stocks generated by our screen. As we noted, several are profitless and many are in troubled markets. Gerber points out that tech insider buying is especially noteworthy, because the sector is awash with stock options. When executives have ample stock options (granted at discount prices), buying shares on the open market shows twice the commitment, in Gerber's view.
So what about the buying at money-losing Corvis (CORV)? The February purchase of 150,000 shares for $12.85 a pop by David Oros, who sits on Corvis's board (and is also the chief executive and chairman of Aether Systems (AETH)), seems admirably risky. But so far, it looks a little questionable as optical-equipment sales slump. The stock has been slashed in half to $6.05 in just six weeks. Plenty of insider selling has followed suit. But because neither Oros nor his Corvis peers have been buying and selling for long enough, there isn't a track record to turn to.
Nortel Network's (NT) president John Roth, meanwhile, spent almost $1 million on his own stock in February. This, too, seems brave. Nortel has also has its share of troubles in the optical networking market and has seen its stock fall 57% to $13.74 this year. But Canadian networker shows more insider consensus, with five different executives opening their wallets this year. And overall, Nortel insiders scored a B with SmartMoney's grading system. That means insiders' timing was better than randomly timed trades. According to our most recent calculations, insiders' gained 40% while random trades in Nortel lost 53%.
Gerber turned our attention to Aspect Communications (ASPT) because board member and venture capitalist Norman Fogelsong has one of the best track records for an insider around, according to InsiderSCORES.com. Twelve out of 13 insider purchases he's made have appreciated over six months, yielding a 71% return on his investments That earns him a top, 100 ranking in InsiderSCORES' books.
Health Care and Insurance
Moving out of tech, some notable insider buying has been going on in the health-care and insurance industries. Check out Pacific Healthcare (PHSY), where three insiders have bought 7,100 shares. After the stock appreciated almost 50% year-to-date and some selling ensued, two insiders purchased shares for between $22.00 to $26.88 on the open market in March. And then there's Coventry Heathcare (CVTY), where two insiders have been buying in March. One of them is Coventry's chief executive, Allen Wise, who also earns one of InsiderSCORES' top rankings, with six out of six past insider purchases posting gains.
With three separate insider purchases, Gerber thinks Aetna (AET) is worth a look, too. Indeed, we found that Aetna insiders have seen their purchases climb 39%, compared with a 4% loss for randomly timed buys. Elsewhere in the insurance world, John Hancock (JHF) was all over our screen results - even as the stock climbs.
Overall? Too Much Selling
But what about the larger picture? You almost don't want to ask. Recent data indicates we're seeing record selling levels. According to Gerber's latest report (dated March 20), February saw $29.10 worth of stock sold for every $1 bought by insiders. "[That's] the highest (most bearish) for this indicator since we began measuring in January 1996," he reported. And for March, data are still trickling in, but the early signs aren't promising. There simply isn't enough buying to indicate that insiders think stocks look cheap yet. (Per SEC rules, insiders have until April 10 to file their March transactions, so we'll get a better picture mid-month.)
But on a case-by-case basis, looking at buying can be more helpful to investors than fretting about selling. Sean Loren, insider research manager of Thomson Financial/First Call, thinks now is a particularly good time to look at buys, not sells. "[Buying] has that much more credibility when stocks are sinking," Loren notes. "It's that much more impressive."
After all, the president of Widgets Inc. may sell shares to pay her children's orthodontist bills, regardless of her opinion of the stock's future moves. By contrast, Gerber notes that insider buyers have little incentive to tie their money up in shares if they don't think they'll go up, "unless it's a PR move, but that doesn't happen often." Nowadays, it's simply too costly.
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