This article is excerpted from Tom Yeung’s Moonshot Investor newsletter. To make sure you don’t miss any of Tom’s potential 100x picks, subscribe to his mailing list here.
Insider Buying Continues
Last week’s newsletter about insider buying seems to have struck a chord with the Moonshot community:
- Outrage. “How do these crooks get away with it?”
- Delight. “Yes! Tell me more about what these fine gentlemen are doing.”
That’s because following insider trades is a lot like watching reruns of Jersey Shore. Reality show stars might be on their most outrageous behavior, but it’s hard to look away.
We don’t want insiders profiting from non-public information — but we’re happy to profit along if it’s done legally.
And that brings us to a massive grey area the size of central New Jersey. Did Elon Musk have insider knowledge when he bought $34 million worth of Tesla (NASDAQ:TSLA) shares in 2018? Or did Mr. Musk simply believe, contrary to public opinion, that his company would succeed in negotiations with bondholders?
Today, we’ll take a look at some of the elements that show which executives are adept at trading their stocks, and illustrate two picks that exemplify these principles.
The Effectiveness of Executive Trades
Regular Moonshot readers already know that the typical executive purchase will outperform the S&P 500 index by 6 percentage points — an amount that compounds to a 3x return over 20 years.
What’s less known are the elements that boost returns.
- Past performance. Executives with strong past performance tend to outperform by an additional 11%, according to TipRanks. The figure rises to 12% when also considering institutional owners — a group that typically has greater experience when it comes to market timing.
- CFO buying. A study published in the Journal of Financial and Quantitative Analysis found that CFO buying out-earns CEO buying by 5% by virtue of being good at predicting future earnings surprises. But CEOs still outperform all other C-suite executives.
- Shorter blackout periods. Most companies on the market have “blackout” periods that prevent insiders from trading around earnings. Shorter blackout periods however, can correspond to greater returns. German companies, which have zero blackout periods, show “very large abnormal returns … due to trades made before such earnings announcements,” according to a study by the Center for Economic Studies.
- Less public information. Executives at small-cap companies earn 7.7% more from their trades than those at large-cap companies. The difference also holds true for companies with low trading volumes. Researchers hypothesize the cause of the gap is that small-cap companies have less publicly available information, making insider knowledge more valuable.
In other words, the Inside Track strategy can land you an extra 20% return or more — if used under the right circumstances.
How to Hide Your Tracks
Finally, there’s one last factor to determining outperformance: trade size.
Imagine a company manager accidentally receives an unpublished financial report. Ordinarily, that manager should let the compliance team know and undergo a trading blackout period until the company releases the official tally.
But what if that manager decided to act on the information instead, reasoning that the numbers aren’t finalized?
Would they make a massive bet, or a smaller one instead?
It turns out that people tend to do the latter, according to academic research. The phenomenon, dubbed the “stealth trading hypothesis” by researchers Barclay and Warner back in 1993 means that executives tend to make smaller trades to act on unusual insight.
Call it human nature. When insiders are doing something financially questionable, they tend to risk less of their total net worth.
In other words, when we see a firm like Cathie Wood’s ARK Innovation (NYSEARCA:ARKK) fund double down on a massive position, that’s not nearly as noteworthy as seeing a CFO slyly add on another 5,000 shares to the 100,000 they already own — at least when it comes to trading on the Inside Track.
CFO Buying: Longeveron (LGVN)
Earlier this week, executives at Longeveron (NASDAQ:LGVN) began buying up shares of the down-and-out biotech research company.
- CFO buying. The General Counsel and Chief Scientific Officer also purchased shares.
- Small-cap company. At $4 a share, LGVN stock is worth just $75 million.
- Relatively small trade. The CFO’s 5,000 share purchase is small compared to the 74,000 shares they already own.
A quick look under the hood explains why.
In late September, Longeveron released preliminary clinical trial data showing that its lead drug candidate Lomecel-B significantly reduced the biomarker Tie-2 in a Phase-2 trial on Aging Frailty subjects.
Wall Street was understandably unimpressed. The NIH estimates that the marginal cost of frailty is $10,690 per year — a significant sum, but not enough to excite most investors.
Longeveron’s study however, might be onto something more.
A closer read reveals that LGVN is using the same Lomecel-B drug in a Phase-1 trial on Alzheimer’s — a far more expensive disease with a similar link to Tie-2 biomarkers. And if Longeveron’s drug can help stave off Alzheimer’s as well as Aging Frailty, it could suddenly find itself in a billion-dollar market.
With clinical results due within the next month, Longeveron’s executives are likely using their knowledge of the Aging Frailty study to predict a strong outcome in the Alzheimer’s trial.
Strong Past Performance: Nighthawk Gold (MIMZF)
Last week, I wrote about how Osisko Mining (OTCMKTS:OBNNF) executives seemed to know something we didn’t. Why would insiders start buying shares of a gold exploration firm on no news?
In reality, the news was on the way. The day after I recommended the stock, the company announced it had discovered one of the richest veins ever on its property. Experienced mining experts, it seems, don’t need official drilling results to know there’s gold under a hill.
Now Nighthawk Gold’s (OTCMKTS:MIMZF) star trader Robert Douglass seems to be up to the same tricks.
In the past month, the CEO of Northfield Capital Corp has bought an additional CAD 300,000 in Nighthawk Mining. And given that he ranks in the top 99.6% of insiders tracked by TipRanks, it’s likely that he knows more about the Nighthawk 24/27 Deposit than official reports let on.
Perhaps it’s unsurprising that Mr. Douglass performs so well. Mr. Douglass is a major shareholder of no fewer than seven different Canadian mining exploration firms. And his track record — a 17x return at Northfield Capital since 1996 — has beaten the S&P 500 index 2.6 times over.
It’s impossible to know what exactly Nighthawk Gold has discovered without visiting their digging sites for ourselves. But at 74 cents and a CAD 74 million valuation, it’s a bet that could be worth taking.
The Morality of Executive Trading
When I first started my career in corporate finance, one of my first lessons was this:
Great company leaders don’t need quarterly numbers to gauge performance.
If a new product goes gangbusters, the CEO will know it long before any Wall Street analyst does. And if the new CMO couldn’t sell a firehose to a person in a burning building, the CFO will quickly realize that next quarter’s figures are going up in smoke.
But sometimes executive trading comes with too much coincidence.
The Case of Video River Networks
Last month, the owner and CEO of Video River Networks (OTCMKTS:NIHK), Frank Igwealor, started buying up millions of his company’s shares. By the end of the month, he had acquired an additional 2% of the company’s free-floating shares.
On Tuesday, it finally became clear why. Video River Networks announced it was launching a “Drive Crypto EV” program, an electric vehicle that mines cryptocurrency as consumers drive down the road.
Whether or not this penny stock will succeed is anyone’s guess. In June, the firm was ingloriously tagged for “stock promotion” by the OTC Market. Attaching a crypto rig to an electric vehicle could be another thinly veiled attempt to woo investors.
But intentional or not, one thing is clear. Mr. Igwealor is certainly wealthier today than when he started. And so are those who followed his lead.
FREE REPORT: 17 Reddit Penny Stocks to Buy Now
Thomas Yeung is an expert when it comes to finding fast-paced growth opportunities on Reddit. He recommended Dogecoin before it skyrocketed over 8,000%, Ripple before it flew up more than 480% and Cardano before it soared 460%. Now, in a new report, he’s naming 17 of his favorite Reddit penny stocks. Claim your FREE COPY here!
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.