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James Dennin, Kapitall: One way to evaluate small cap stocks is by looking for insider buying, when people on staff are buying shares.
Investors should consider positive trends in insider buying when evaluating small-cap stocks. While that sounds illegal, insider buying is permissible if you're trading on information that is open to the public.
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For many reasons, company insiders have a better outlook on a stock's potential growth than analysts do. With knowledge of their field, insight into their company's future plans, and understanding of inventory and supply-lines, insiders have information at their fingertips that vastly outweighs the data available to analysts.
Nevertheless, it's crucial that you look at the context of the insider buying and selling – is it a single marketing executive raising money for his kid's college tuition? Or are a number of executives loading up on shares, signalling confidence in their business plan and exciting announcements on the horizon?
It's important to understand that this strategy really only applies to smaller companies. For a big conglomorate like
Coke (KO) or
General Electric (GE), the activities of a single department aren't usually enough to move the needle for the whole company. And executives in New York won't necessarily be privy to the details of what's going on at corporate offices in India.
For smaller companies, however, it can be a great way to screen for stocks within an unfamiliar niche market. And with riskier plays, it's always a comfort to see management that's putting their money where their mouth is.
We decided to build a list of rallying stocks with spikes in insider buying. So we started with a universe of equities that are all trading at least 30% above their
50-day simple moving average (SMA 50). Taking this list of around 200 companies, we futher screened the list for companies who'd seen at least 1% of their float purchased by company insiders.
That left us with 4 small cap stocks on our list.