Don’t Be Fooled by Meaningless Insider Buys

by Ethan Roberts | March 19, 2013 8:50 am

There’s a bevy of ways to analyze stocks. Fundamental investors like metrics such as P/E and cash flow, while technical analysts like resistance and moving averages, among others. Some investors — myself included — combine these distinct approaches to make their stock selections … but there’s one additional thing I make sure to scope out.

Namely, I like to look for insider buying among corporate officers as confirmation that insiders are feeling positive about the company’s prospects, and I give an extra “check mark” so to speak, when I see that important insider buying has recently occurred.

Insider buying is more important than insider selling because selling is often done for personal reasons that could have nothing to do with an insider’s feelings about the stock. A CEO is buying a new home or a boat. A Vice President plans to leave the company soon. A CFO is getting divorced.

However, insider buying often signals that the stock will be appreciating in the near future. Company insiders have the most detailed and up-to-date information on their company sales, earnings and outlook. They have a distinct advantage over company analysts and an even greater advantage over the general public. A number of financial studies over the years have found conclusive evidence that the returns from following insider buys are greater than those of the overall market.

At the same time, not all insider buying is significant … and sometimes it can downright fool you if you don’t know how to distinguish between the gold and fool’s gold. Let’s take a look at three energy companies as an example.

Our first stock under consideration is Hess Corp. (NYSE:HES[1]), the well-known oil company. Several corporate insiders at Hess have made purchases lately … a good sign, right?

Well, if you look more closely at them, they were all made on the same day … with the same number of shares … at the same price … and with the same total value. That signifies that this was an automatic purchase — set up well in advance for the officers — and would have been made whether the stock was trending higher, lower or sideways.

Purchases like these mean nothing for the company’s prospects and are best ignored by investors.

insiderbuying12 Don’t Be Fooled by Meaningless Insider Buys

Next, let’s look at Ferrellgas Partners LP (NYSE:FGP[2]), a Kansas-based energy company that engages in the distribution and sale of propane, equipment and supplies in the U.S.

Ferrellgas has had insider buying for quite awhile, and purchases were made on a regular basis. Still, the stock price purchases have all been made in round lot numbers at $11.63, while the stock price was trading well over $19. This tells us that the purchases have been made at a discount from shares that were probably already held by the company or through some other special arrangement.

Even if an insider was lukewarm on his company’s prospects, the opportunity to purchase company stock at 40% below current value is a no-brainer. However, this type of purchase is also nothing for investors to get excited about.

insiderbuying4 Don’t Be Fooled by Meaningless Insider Buys

Now let’s compare these corporate buys with those of Tetra Technologies (NYSE:TTI[3]), a Texas-based diversified oil and gas services company with significant insider purchases made in November 2012.

You can see from the table below that a number of different insiders were purchasing shares of different amounts and at different prices. Most of the purchases made were within one week and had larger total values. These are the kind of purchases that are more significant and should be a signal to investors that profitable times are ahead.

insiderbuying3 Don’t Be Fooled by Meaningless Insider Buys

Not surprisingly, as the accompanying chart shows, TTI has rocketed up about 85% since November and the chart continues to look healthy, with another strong 4% move higher on Thursday of last week. Clearly, the insiders were optimistic for good reason when they made their purchases.

insiderbuying Don’t Be Fooled by Meaningless Insider Buys
Click to Enlarge

So don’t be fooled by automatic purchases or discounted price buys. What investors should be looking for are more significant insider buys, such as the ones at Tetra Technologies.

Of course, remember to do your other homework as well and never rely on insider purchases as your only reason for buying a company’s stock. But sort through and apply the right data, and you will find your best profit potential.

As of this writing, Ethan Roberts did not own a position in any of the aforementioned securities.

Endnotes:
  1. HES: http://studio-5.financialcontent.com/investplace/quote?Symbol=HES
  2. FGP: http://studio-5.financialcontent.com/investplace/quote?Symbol=FGP
  3. TTI: http://studio-5.financialcontent.com/investplace/quote?Symbol=TTI

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