Stocks following insider buying outperformed the market by 4.5%There is plenty of data that supports this conclusion. According to Catalyst, research by H. Nejat Seyhun published in, Investment Intelligence from Insider Trading, The MIT Press, 1998, between 1975 to 1994, stocks following insider buying outperformed the market by 4.5%, while stocks following insider selling underperformed the market by 2.7%. These results are based on an exhaustive data set, capturing information on insider trading in all publicly traded firms over two decades, around one million transactions! Nejat Seyhun concludes that on the whole, insiders do earn profits from their legal trading activities and their returns are greater than those of the overall market. However, investors should not necessarily follow insider deals without doing their own research. Investopedia’s description of insider dealing which really sums up the whole argument. “…Surges in insider trading appear to divine an upcoming switch in the market’s direction. But outside investors have to be awfully careful about reading positive messages into every insider buy they see. Investors must also avoid treating individual sales as signals to unload their own holdings…” Moreover: “…Research supports the view that insider information works best in the aggregate. Independent research firm Market Profile Theorem MPT showed that insider trading trends signal an up-and-coming shift in market sentiment…”
Insider buying poorly timedThe key criticism of following insider buying is that while insiders may know their businesses well, they are not sophisticated investors, as a result, their purchases can be poorly timed. This is compounded by the fact that executives usually view their company through rose colored glasses.
British newspaper, The Times only this week reported on a study from Banc De Binary, an options specialist, supporting the above statement. The study analyzed the performance of ten FTSE 100 companies with the highest boardroom shareholdings and the ten lowest boardroom share holdings. The results showed that companies with a high management shareholding underperformed those with a low management shareholding over the past year.However, a similar study, conducted over a longer five year period showed that the boards with the largest shareholdings presided over a better long-term share performance, confirming the Investment Intelligence study.