A few years back at an investment conference, a participant confessed to me his surprise at the amount of insider selling he had noticed in some of his stocks. He was concerned about whether he should offload those stocks too. But should he really? Well, not necessarily.
There’s a host of reasons company executives might decide to sell stock, and many of these reasons don’t reflect on how they view their company’s future. Take diversification, for instance. Insiders might sell shares simply to spread their investment risks.
Consider Bill Gates, a prominent figure who has been selling his stake in Microsoft (Nasdaq: MSFT) periodically for decades. Does this mean he’s lost confidence in the company he co-founded? Absolutely not. Most of his wealth is closely tied to Microsoft’s stock. But even someone like Gates has financial responsibilities. From time to time, he must liquidate shares to cover expenses and support his ventures.
Moreover, insiders might feel compelled to sell due to personal financial obligations, such as investing in property, covering their children’s Ivy League tuition, or due to circumstances like divorce which may require them to offload shares.
While there are numerous personal reasons for insiders to sell, it’s important to remember that these do not necessarily reflect the company’s immediate future prospects. Conversely, there are scenarios where insider selling is directly linked to a company’s outlook.
Take the case of Enron; their insiders sold $1.1 billion worth of stocks in the year leading up to the company’s bankruptcy. Sometimes, insider selling is a cautionary tale, but at other times, it’s just business as usual.
Let’s flip the narrative for a moment. Ever wonder why insiders would decide to buy large quantities of their own company’s stocks at current market prices? There’s usually only one reason: they believe these shares are trading for far less than what they’re truly worth, based on all the inside knowledge they possess, including insights into operations, relationships with suppliers, customers, and competitors.
This kind of insider buying is a signal worth paying attention to. For nearly four decades, I’ve been keeping track of insider buying. In early 2020, through my VIP Trading Services, I recommended At Home Group, a home décor superstore chain. The company had missed its sales and earnings forecasts in recent quarters, causing its stock to plummet from over $40 to about $6.
To the casual observer, At Home seemed doomed, particularly with most of its revenue coming from traditional brick-and-mortar stores during the onset of a pandemic, which threatened mass store closures. Despite this, I pointed out that insider Clifford Sosin, who owned more than 10% of the company’s shares, had acquired an additional 470,000 shares.
It’s not typical for insiders to waste their money frivolously, and Sosin had a solid track record with previous smart insider buys. Sure enough, the stock rebounded, and by early 2021, At Home had struck a deal to sell itself to private equity firm Hellman & Friedman for a hefty $2.8 billion cash, roughly equating to $36 per share.
Now, does insider buying always yield such favorable outcomes? Of course not. No signal is foolproof. However, insiders do enjoy a substantial, unique advantage. This is why federal regulations mandate that insiders file a Form 4 with the Securities and Exchange Commission every time they trade their company’s shares.
Insider buying is one of the clearest signals available. When you notice officers and directors investing in their own company’s stocks, the opinions of analysts suddenly lose their shine. These analysts are often juggling coverage of numerous stocks, while insiders are deeply involved in running their one company.
Analysts lack access to confidential, non-public information. Insiders, on the other hand, have this at their disposal. Furthermore, while analysts offer opinions, insiders are actually risking their own finances.
So, whose insight would you rather rely on?
