It's disturbing but true: No matter how much time you spend researching a company, you'll always be a step or two behind the people running it. While you dissect the 10-K, they're test-marketing new products. While you watch the talking heads on
, they're cutting deals with
There is, in short, no substitute for being there. Except maybe this: If you track what a company's insiders (i.e., its officers, directors and major investors) are doing with their stock and
interpret that information correctly
, you're getting the distilled essence of inside information.
From a legal standpoint, there are two kinds of insider trading: the criminal kind, which is defined as acting on "material, nonpublic" information before it's released, and the legitimate kind, which is buying and selling based on a more general sense of how things are going. Even the regulators argue about which is which, but all you really have to know is that the
Securities and Exchange Commission
requires insiders to tell the world about their trading activity. A growing number of Web sites, including
Individual Investor Online
, offer the raw data for free. Just type in a ticker symbol, then click "insiders," and up comes a chronology of who did what at what price.
Analyzing these data can be tricky, however. A reasonable amount of selling, for example, doesn't tell you much, since insiders often have most of their net worth tied up in their company's stock and quite rationally want to diversify.
has been selling Microsoft stock all along, without a noticeable effect on its price.
, head of
, recently generated a modest buzz by dumping 4 million shares -- until everyone remembered that he owns 350 million shares. And even when it seems like an executive is selling most of his stock, it's a false alarm if his options package dwarfs his actual stock holdings.
Buying is a better indicator, since if insiders already have most of their net worth tied up in their firm's stock, then wanting more is a sign they really like what they're seeing. But here again, things aren't always what they seem. Some companies require officers to convert part of their compensation into stock, which results in big buys around bonus time. And occasionally, Machiavellian insiders will sell big, then turn around and buy smaller amounts to throw analysts off the trail.
At successful companies, a huge amount of buying is forced by the expiration of options, which become worthless if not converted to stock. This often shows up as a large number of buys at odd, very low prices, followed by sales at current market prices. Insiders at
, for instance, recently exercised options to buy several hundred thousand shares at 8 55/64, and then sold most of them for around 100 a share, cashing out without changing their net stock positions. This is an important point: If options are exercised and the stock is then sold, that's neutral. But if options are exercised without offsetting sales, that's the same thing as insiders buying on the open market -- a bullish sign.
Remember, insider trading is only predictive if it's broad-based, steady and/or really big in relation to insiders' current holdings. An example of how this can play out is restaurant chain
Dave & Busters
: When its stock dropped late last year, an army of insiders started buying and kept it up until the stock more than doubled (at which point they started selling). And on the negative side, massive insider selling at
in May and June preceded this week's warning by the company that second-quarter earnings would fall short of analysts' estimates. (See
column for details.)
For probably the best analysis of current insider activity, see
column, or his
Insider Chronicle newsletter, where he cooks each company's insider activity down to one "insider index." And for a window on future insider trades,
IPO Pros site tracks Form 144s, which insiders have to submit to the SEC before selling.
Now let's bring this discussion into the present (giving me an excuse for a follow-up column one of these days) by listing some companies that have seen a lot of recent insider buying: banana grower
, where Chairman Carl Lindner has bought about $20 million of stock in the past year through June 1; sporting-goods maker
, whose Chairman Sam Johnson has bought about 250,000 shares, worth over $3.5 million since last August; and pipeline operator
, where nine insiders have bought in over the past two years, all in chunks of 10,000 shares or less. (I own a little of this thinly traded stock. Its growth strategy is in transition right now, so don't buy without serious further research.)
Are these stocks guaranteed winners? That's the same as asking if big, broad, one-sided insider trading is an infallible indicator, and the answer is of course not. Insiders are human, and often, despite their perspective, they're flat-out wrong. Managers at
sold huge amounts of stock for less than 20, not long before the company was bought out by
for about 85 a share. More recently, several insiders at
bailed just before a merger with
sent its price soaring.
So treat insider trading as one of those other-things-being-equal aspects of security analysis, as in
other things being equal
, it's better to go with the insider flow than against it.
John Rubino, a former equity and bond analyst, writes a column on mutual funds for POV and is a frequent contributor to Individual Investor, Your Money and Consumers Digest. His first book, Main Street, Not Wall Street, was published by William Morrow in 1998. At time of publication, he was long Virginia Gas. While Rubino cannot provide investment advice or recommendations, he invites your feedback at