When Is Insider Selling a Bad Sign?

by Ethan Roberts | September 5, 2013 7:00 am

Few things are more anxiety-producing than hearing company insiders of your favorite stock are about to sell a large numbers of shares. The stock may be cruising along, delivering images of that trip to Hawaii or 40-foot boat you’ve always wanted. Then you hear an announcement like this:

youngInvestorsB.png When Is Insider Selling a Bad Sign?[1]“Google (GOOG[2]) co-founders Larry Page and Sergey Brin plan to steadily sell off up to 10 million shares of stock over the next five years, according to an SEC filing[3].”

That announcement came out in January, 2010. However, since then, GOOG has risen from about $550 to its current price of $870. While those sales may have stalled Google’s appreciation somewhat, had you sold your Google stock in January 2010 expecting it to crash, you would have missed that 60% rise.

It’s often said insider selling can be a tip-off that insiders know their stock is about to underperform the market. While that’s sometimes true, it’s also true that quite often insiders sell for personal financial reasons that have absolutely nothing to do with bad times ahead for their company.

So, when insiders at a large publicly traded company begin to sell off a large amount of stock, how do shareholders know if they should rush for the exits? Let’s take a look at the nuances that dictate whether inside sales are cause for alarm.

Don’t Panic

These days it’s also common for companies to pay smaller salaries to company insiders and compensate them instead with stock shares and options. Keep this in mind, because often an insider could be selling shares simply to raise some personal capital.

It’s also an axiom of the stock market that while insider selling is often insignificant because it can be done for any number of reasons, insider buying almost always indicates that the corporate officers have reason to believe better times are ahead. Therefore, insider buying is usually much more important than insider selling.

But how do we decipher the insignificant from the more significant insider selling? Here are several clues that the selling can probably be ignored:

So, looking at the Google insider trades, the sales were scheduled far in advance, have to-date been performed over a dozen successive quarters and at a wide range of prices. In essence, during this three-year period, this selling has been the norm — rather than the exception — and is, therefore, not really notable.

Red Flags

Conversely, several telltale signs indicate when insider selling may be significant and a warning that a large drop in price is expected over the next few months:

Another thing to note is that when the level of overall insider selling across all stocks rises, it often indicates that the stock market in general may be about to reverse course and head lower.

Still, the bottom line is simple: Don’t automatically assume the worst when you hear about corporate insiders selling stock. Instead, using the criteria outlined here to make sound decisions about to whether insider selling means it’s time to head for the exits.

As of this writing, Ethan Roberts didn’t hold a position in any of the aforementioned securities.

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Endnotes:
  1. [Image]: http://investorplace.com/hot-topics/young-investors-series/
  2. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  3. SEC filing: http://www.sec.gov/Archives/edgar/data/1288776/000119312510011019/d8k.htm
  4. Sign up for our Young Investors e-letter: https://order.investorplace.com/index.jsp?sid=QL8104

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