Investors have long known that insider buying trends provide insight into the people who know the most about a company’s fortunes. If insiders are willing to stake their personal fortunes on their own company’s stock, the thinking goes, then average investors should do the same.
The insider buying signal came into the spotlight just two days ago, when General Electric (GE) CEO Jeffrey Immelt announced he was pouring his entire $2.6 million bonus into GE stock. In this case, the markets certainly got the message: GE shares have rallied 3.2% in the past two sessions.
But just how much value does tracking insider buying add over time?
Based on a recent study and an ETF that invests in stocks with heavy insider buying, the answer is “quite a bit” – on both short- and longer-term bases.
A Meaningful Return Advantage
Perhaps the best set of free, publicly available evidence is S&P Capital IQ’s October 2013 piece “Informative Insider Trading – The Hidden Profits in Corporate Insider Filings.” The study shows that insider buying as a whole is a net positive for returns in the week following the announcements, but it’s a particularly effective signal when it comes in three forms: non-recurring purchases, “intensive buying” (i.e., more than one official involved), and a directional change (when a seller becomes a buyer). Purchases by CEOs also tend to provide stronger signals than purchases made by other insiders.
This is good to know, but it assumes investors have the opportunity to monitor Form 4 filings throughout the day and react immediately. For most of us, this isn’t remotely realistic.
Also, investors who pick and choose individual stocks with heavy insider buying might not necessarily be getting the full bang for their buck. There are two reasons for this:
- First, an executive’s decision to buy doesn’t occur in a vacuum. Insiders know full well that their transactions will be filed, will show up on websites such as insidertrading.org, and in some cases will be reported by the media. For an example, we need look no further than Jeffrey Immelt’s purchase of GE stock this week. In this sense, the knowledge that the purchase is publicly reported — and can have a meaningful impact on price, even for the General Electrics of the world — skews the significance of the act.
- Second, as laid out in a white paper titled “The Sabrient Insider Sentiment Index,” — authored by Joshua Anderson, Ph.D. for Sabrient Systems — insiders have a tendency to accept an inferior risk-return profile with their own company’s stock for a simple reason: peer pressure. Anderson writes, “…people are also apt to overestimate the value of their special knowledge or to be overly optimistic about their own firm’s chances for and magnitude of success. In a way, there is a risk to insiders in not investing, since if their firm does well and they opted not to buy, then they will feel less well-off than their colleagues who did buy more. It is plausible that insiders might be willing to accept a higher risk for the same level of expected reward in their own stock.”
Guggenheim ETF Adds Another Dimension
So how can investors profit from insider buying?