Can insiders tell the future?
By Lisa Meyer
Red Herring
March 20
As everyone tries to figure out just when the bear market for technology stocks will finally end, we'd like to present you with this sobering fact: unfortunately, there has been far more insider selling than buying lately in the overall market, particularly in the tech sector -- and that's not an encouraging sign.
According to Lon Gerber, director of research at ThomsonFN.com, for every $28 worth of shares sold by corporate insiders, only $1 was bought in January. But such an imbalance was driven by lack of buying rather than any acceleration in selling, Mr. Gerber adds. The total value of shares sold in January was $3.5 billion versus the $125 million in shares bought, according to ThomsonFN.com.
'This was the lowest monthly activity in buying since September 1995, which is somewhat surprising given where the market is today,' he says. 'Insiders, who are often value investors, like to step in when the market has overreacted.'
Indeed, the fact that insiders haven't plucked up depressed shares might reveal a lack of confidence in the overall market. Given the plunge the Nasdaq has taken over the past several months, there is little doubt that panic selling has gripped even top insiders as well as the average individual investor. To illustrate this point, we used the Thomson Financial/Baseline database to find technology and telecommunications companies that had at least five more insider sells than buys in the last three months and a stock price that has dropped more than 50 percent during the same time period.
We found 32 companies. Interestingly enough, several of these firms' stocks have fallen due to earnings warnings, including semiconductor measurement systems provider Keithley Instruments (NYSE: KEI), speech recognition software provider Nuance Communications (Nasdaq: NUAN), and chip makers Applied Micro Circuits (Nasdaq: AMCC) and Broadcom (Nasdaq: BRCM).
TIMING IS EVERYTHING
Nuance provides one of the more glaring examples of a company whose insiders sold before an earnings warning. Just after reporting positive fourth-quarter earnings and just before reducing guidance for its first quarter, a number of top executives sold shares on the open market.
On January 30, the company announced a 206 percent year-over-year increase in revenue during the fourth quarter to $17.4 million, up from $5.7 million for the same period last year. Losses were 4 cents per share lower on a sequential basis. But since then, the company's outlook has deteriorated. On Friday, Nuance announced that its losses per share in the first quarter would increase to between 31 and 38 cents, versus the First Call estimate of 23 cents. The company's stock plunged 43 percent on the news.
But by selling a significant portion of their holdings before this announcement, the company's CEO, vice president of business development, and chief financial officer partly escaped Friday's market downdraft. Between February 7 and 13, CEO Ronald Croen sold 223,700 shares within a range of $37.08 and $40.23 a share for a total market value of $8.69 million, according to ThomsonFN.com. During the same week, VP of business development Lloyd Leanse sold 33,604 shares within a range of $34.89 and $41.94 for a total market value of $1.32 million, and CFO Graham Smith sold 45,100 shares within a range of $34.63 and $38.61 for a total market value of $1.65 million. The stock now trades at $10.75.
John Corcoran, an analyst at CIBC World Markets, suggests that such timing made him suspicious. 'We can put two and two together,' he says. 'That's not suggesting that there was any nefarious doings. But the stock has been under pressure.'
Mr. Corcoran adds that the total holdings these executives had in Nuance were probably a significant portion of their net worth. 'They sold probably to diversify,' he says. Despite the company's current troubles, Mr. Corcoran believes that Nuance has a good chance to rebound when the overall market revives. 'We aren't talking Pets.com part two,' he explains. 'We are talking about proprietary technology with Nuance. The company sells enterprise software that makes businesses more efficient.'
IF IT LOOKS BAD, IT IS BAD
The CEO of Keithley Instruments also sold a significant portion of his holdings just after a positive earnings report and before a profit warning. On January 18, the company announced net income of $6.9 million, or 42 cents per share, for its first quarter, a 115 percent increase from $3.2 million, or 21 cents per share, in the same period last year. But, like Nuance, such good news didn't last. On March 12, the company cut sales and earnings estimates for its second quarter, causing its shares to fall 28 percent that day. The warning came after Keithley previously reassured investors a couple of times that it was on track to meet estimates.
Four days after the company's first-quarter earnings release, CEO Joseph Keithley sold 41,500 shares at $59.03 for a total market value of $2.45 million, according to ThomsonFN.com. The stock was trading at $15.50 as of March 19. Even though Mr. Keithley has periodically sold company shares over the past nine months, one analyst thinks the timing of the recent sales makes management look bad.
'Fundamentally, Keithley Instruments has a good story, a good product, and is well run,' says Pacific Growth Equities analyst Joe Noel. 'But it is also important to caution investors: the management team needs to learn a lesson in investor relations. The team needs to build credibility because investors got so burned.'
Other CEOs that sold shares before a profit warning include: Applied Micro Circuits's David Rickey, who sold 40,644 shares at $70.21 for a total market value of $2.85 million on February 2 and 167,000 shares at $80.13 for a total market value of $13.38 million on January 18; and Broadcom's Henry Nicholas, who sold 450,000 shares within a range of $62.40 and $86.78 for a total market value of $32.22 million between February 12 and 23, 50,000 shares within a range of $79.42 and $85.58 for a total market value of $4.12 million between February 7 and 14, and 25,000 shares at $115 for a total market value of $2.88 million on January 30. Applied Micro and Broadcom now trade at $22.81 and $34.31, respectively.
NOT A PERFECT INDICATOR
It is worth noting, however, that insider selling is not always tied to a company's fundamentals. Insiders might sell to diversify their portfolios or acquire liquidity for personal reasons, like buying a house. Moreover, as an increasing number of technology companies use stock to compensate employees, many of them need to sell shares to actualize income. Internet security management company Internet Security Systems (Nasdaq: ISSX) and e-business software provider Siebel Systems (Nasdaq: SEBL) are just two of the companies that made the screen but didn't issue profit warnings recently.
To be sure, a skeptic would say that insiders at these companies have been selling in anticipation of possible future earnings shortfalls. Indeed, because the businesses of many technology companies are interconnected, a warning at one company could reverberate across several markets. Siebel's stock, for example, has plunged mainly due to concerns that the problems affecting Oracle (Nasdaq: ORCL) will spread to Siebel and other e-business software companies.
At the very least, investors should be aware that insider selling, while not a perfect gauge of future stock performance, is a possible sign that a company's stock price might have more downside. 'When insiders act bearish, it is often an accurate reflection of the coming months and that bad times are up ahead,' Mr. Gerber says.
Nevertheless, taking a closer look at the timing of recent insider selling shows that insiders at some companies are still gaining the upper hand in the market by selling off shares before the stocks tank due to profit warnings. And once again, individual shareholders are left holding the bag.
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