Opinion: Many investors misunderstand inside trading

The list of insider buys and sells is available from various sources, the most frequently used being the daily (except Monday’s issue) report in The Wall Street Journal. Normally found in either the B section or C section (check the index), it presents insider transactions by company name and stock symbol, followed by the name of the insider and his title, and then the specific transaction information: the dollar value, number of shares, range of share values and transaction dates. (Note that the list does not include pure options transactions, the back-dating of which by some companies has led to intense scrutiny by the Securities and Exchange Commission.)

Of the two types of transactions, those by sellers are the least valuable in determining whether one should own, sell or short a stock. Often the reason for the insider’s sale of the issue is related to either an estate-planning or diversification concern. It is not hard to imagine, for example, that a 70-year-old stockholder/officer with the majority of his wealth tied up in company stock would prefer to lighten his ownership at a long-term capital gains tax rate rather than see Uncle Sam get a chunk of it at the confiscatory estate tax rates.

Or if an officer, understanding the risks of not being diversified, wished to avoid having too many eggs in that particular basket. (Want to check out ages and stockholdings of the insiders? An easy source is Yahoo! Finance’s Insider Holdings and Insider Transactions.)

A red flag

Those are not, therefore, reasons to read a negative into such actions; however, there is one situation that should raise a red flag and give reason for looking further into the sell transaction. That is when the transaction takes place at prices near the stock’s 52-week low. That can be a sign of a real problem, as insiders prefer to sell at historically higher prices and normally hold on or add to their positions if the stock is at a low price and they believe the outlook for the company is good.

The potentially more profitable information comes on the insider buy side.

First, think just opposite to the selling at a stock’s low point just discussed. A very positive sign is insider buying when the stock is at or near a 52-week high. That’s a reflection of real optimism on the part of the insider. Who knows better the outlook for the company than those who run it? And the larger the dollar amount of the purchase, the better. It doesn’t hurt to check what that amount is on a percentage basis relative to the insider’s position in the stock prior to the purchase. An insider buying $50,000 worth of his company’s stock to add to a multimillion-dollar position doesn’t carry the weight of an insider buying stock valued well in excess of his existing holdings. (Again, note that these are non-option related transactions.)

So, can you benefit from this legal insider trading information? We don’t take any action solely on the basis of what the insider’s do – nor should you. It can give you a starting point for looking further into the company’s stock using the fundamental and technical screens we have written about in previous columns.

(For more on these fundamental and technical screens, please view my archived columns at sbj.net or e-mail me.)

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.