What insider trading says about future of a company
While stock transactions by officers and directors
don't clearly shout "buy" or "sell," they do hint at prospects.
By Miriam Hill
Philadelphia Inquirer
Posted on Tue, Mar. 19, 2002
At Enron Corp., the jackpots came easily and quickly: Since 1998, company
executives and directors sold stock worth $1 billion.
In hindsight, the massive sales of Enron stock by chief executive officer
Kenneth Lay and other insiders should have raised a red flag, brightly painted
with the word sell, for investors wondering about the company's future.
If only it were so easy. Unfortunately, sales and purchases of company
stock by corporate executives and directors do not always telegraph information clearly.
Microsoft Corp. founder Bill Gates regularly sells shares of the software
company's stock, for example, but investors do not interpret that negatively
because the stock has done well in the past after he has sold.
While insider transactions rarely shout "buy" or "sell," they do
often hint at a company's prospects.
Many professional investors, as they pick stocks, weigh the data,
which must be filed with the U.S. Securities and Exchange
Commission within 10 days from the end of the month in which
the transaction occurs. The information is available free on the Yahoo
Web site. (Click on "finance," type in the company stock ticker,
and click on "insider.")
"Usually, it's a good sign if executives are buying and a bad sign
if they're selling," said H. Nejat Seyhun, professor of finance at the
University of Michigan. "But you can't place sure bets. It's soft
information. I wouldn't base my entire trading decision on what
insiders are doing. I would look at it as a signal among other signals."
Insider trading can be illegal, but usually only if an executive trades
with specific advance information that will move the stock price, such
as a strong earnings report, or a merger announcement, Seyhun said
When insiders sell or buy based on general information about a
company's long-term prospects, it is generally legal.
Most of the time, insider purchases are a stronger signal than sales.
That's because executives and directors have a host of reasons for
selling - to make a charitable gift,
to diversify investments, or to pay for a child's college education.
Insiders have few incentives to buy their company's stock unless
they believe it is going places.
Long-term studies have shown that insider purchases,
especially at companies whose stock price is cheap
relative to the overall market, generate outsized returns,
said John D. Spears, co-manager of Tweedy, Browne
American Value Fund and Tweedy, Browne Global Value Fund.
When he picks stocks for his funds, he seeks out companies whose
shares are inexpensive relative to earnings or book value. News
about insider purchases often tips the balance in favor of buying.
When the Clinton administration's proposals for health-care
reform pummeled drug stocks in the early 1990s, for example,
Spears noticed that Johnson & Johnson director
Thomas Murphy had bought about $1 million worth of shares.
The company's shares were selling for about 12 times earnings,
so Spears bought.
"It's been a good, long-run winner," Spears said.
Context is the key to judging insider sales and purchases.
Jeff Auxier, manager of the Auxier Focus Fund, sold Enron
shares in part because he didn't like the pattern of
insider selling. The sales bothered him especially
after Enron executives grew increasingly defensive when
asked about earnings.
The Houston energy trader, once a darling of the New Economy,
collapsed in bankruptcy in December amid allegations of questionable accounting.
Lon Gerber, director of insider research for Thomson Financial, advises investors
to consider whether an executive's or director's decision to sell deviates
from a normal pattern of selling. If so, it may signal a problem.
Similarly, executives and directors selling as a group may hint at trouble.
Group buying, on the other hand, suggests confidence in a company's
future. Insiders tend to be good judges of what their companies are worth,
Auxier said, so they buy when they think the stock is undervalued.
About 18 months ago, executives at Cinergy Corp. began buying
large stakes. The stock has risen from about $20 when they
purchased it to $33.80 yesterday.
Insiders who sell as a company's stock price plummets - which
happened at both Enron and Global Crossing Ltd., which also filed
for bankruptcy recently amid signs of
accounting irregularities - should raise investors' eyebrows,
said Seyhun, who wrote Investment Intelligence from Insider Trading.
"Insiders can give you lots of different reasons as to why they're selling,
and there's truth to all of those," Seyhun said, "but what I've found is, if
insiders are selling as prices are going down, it's a bad sign.
If they're selling as prices are going up, that's not as bad."
Insider sales followed by a quarter in which a company reports
a break in a string of record earnings also bode ill for the stock,
said Pennsylvania State University business
professor Steve Huddart.
Aggregate insider data also offer clues to the performance
of the overall stock market, Gerber said. Insider sales generally
outweigh purchases by a ratio of 12-1. That ratio
got as high as 20-1 in 2000 and 2001, suggesting
insiders were bearish on the market. But the number began
improving in September.
"It's indicating," Gerber said, "that the market might represent
some decent opportunities right now." |
