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Recently, a friend asked me to write more on ths usefulness of insider trading indicators. Here are some findings which can be found in research conducted by insider trading expert , Nejat Seyhun.
The First most basic question is : Does insider trading help to predict any form of stock market returns?
It has been found that stocks with insider purchases actually outperform the market by 4.5% and stocks with insider sales actually underperform the market by 2.7%. But it is important to note that insider sales may not necessarily mean a bearish signal as sales by insiders can mean that they need the money to purchase a new home , car etc not indicative of stock moves to the downside entirely.
What kinds of stocks should i buy a longside the insiders?
One should buy stocks with insider purchases focused on small cap companies. On average, insiders earn 6.2% in small companies as opposed to 1.7% in large caps. Ahmet of Okumus capital has been getting astounding returns of 33% per annum. In fact in his earlier years, he had been doing way better and the reason for it i feel is that he focuses on beaten down small caps with insider purchases.
Does insider purchases predict dividend hikes or initiations?
No there is no correlation.
Does insider trading predict an upside in the coming earnings quater or upside surprises?
No there is absolutely no correlation.
Does insider trading predict the success of a merger or acquisition?
Nope it does not. Prices of target firms rise due to institutional participation and not insider purchases. Besides trading on information which have a material effect on price before it is disclosed is illegal.
One point to note is that although insider purchases are normally followed by stock moves to the upside, it is of my opinion that these stock moves are a "psychological" market phenomenon and not necessarily mean that the stock is undervalued. The market would reason it this way: since the insiders are buying it must mean that something good must be happening so lets hop on and join the band wagon. I feel that there are flaws inherent in such surfacial thinking to say the least and i do beg to differ. Firstly, insider buying may not necessarily mean that the company is priced at a discount to its intrinsic value. For example, i came across an alternative energy company(ener). it was trading at a forward PE of 60 and the insiders were scooping it up. I thought to myself that this guy surely does not know what he is doing and is going beyond logical reasoning. Hence, it is always important to combine insider trading with fundamental analysis to gauge the true value of a company before buying into one. Do not do it blindly!
Feel free to pose me and manpreet any questions regarding this.
Better and better,
Lucas
Sunday, November 11, 2007
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2 comments:
Can you help with a similar question? What does it mean if an insider purchases preferred stock at a discount?
Hi Joan,
It can mean that:
1. Insider purchases it at a discount to par value
OR
2. Insider purchases it at discount to common stock value
OR
3. Discount to intrinsic value
Insiders only buy for one reason and that is to make money.
In this case, check if Interest and Preferred dividend coverage ratio is healthy... at least 3 times. Test this ratio against recessionary earnings and see if it is healthy
It will be good if company has net cash. (Total cash and cash equivalents - total debt)
Generally debt is a prededent to Preferred stock which is a precedent to Common Stock when company files bankruptcy.
If the company can sufficiently pays its interest payments and there are no short term maturing debt which they cannot handle and there is a net cash balance and it can further pay its preferred dividends against the backdrop of recessionary revenue and earnings and the preferred is undervalued with a high yield, then it would make sense that what the insider is doing is correct and by correct i mean buying of undervalued security.
Best regards,
Lucas
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