Profit From the Insiders' Data

Every day, U.S equity investors can invest in more than 8,000 stocks. Such a huge opportunity, though, is also hugely confusing. How do you start narrowing down your investment choices?

Value investors may start by looking for stocks with low price-to-earnings or price-to-book-value ratios. Growth investors likely screen quarterly financial results looking for stocks with great year-over-year earnings comparisons. Momentum investors probably prefer to look at the "percentage gainers" list and stocks with large trading volume increases. But all of these investors could increase their returns if they started their stock-picking by looking at the same information flow: insider trading data.

The legal insider data reported on the SEC's Form 4, as well as SEC documents recording transactions by institutions, are a great source of investment ideas no matter what style you prefer and no matter what type of market we're in. It's also invaluable for following stocks you already own. After all, who's in a better position to know a company's prospects than its own management?

In a victory for common sense, academic studies show that this SEC data is useful for garnering "excess returns" in stocks. A more important testimony comes from institutional investors, many of whom have successfully used the SEC's insider data to help make their investment decisions for years.

In fact, professional investors have enjoyed timely access to the SEC's insider trading data for decades, finding it lucrative to pay what it takes to access the most up-to-date detailed electronic databases. Starting in the early days of computers, institutional investors paid private firms to manually key in Form 4 and other insider trading data from the original paper forms filed with the SEC. By the time individual investors got the affordable public versions of the data from the SEC itself or free Web sites, institutions had already traded on the information. Perversely, the data that were meant to level the playing field for individual investors was giving institutional investors yet another leg up. That situation lasted well into the 1990s.