It pays to know what a company's owners are up to. By watching the trading activity of corporate insiders and large institutional investors, it is easier to get a sense of a stock's prospects. While insider or institutional ownership on its own is not necessarily a buy or sell signal, it certainly offers a handy first screen in the search for a good investment. Here we offer a quick review on how you can find and use insider and institutional-ownership information to make well-informed investment decisions.

Insider Ownership
Insiders are a company's officers, directors, relatives or anyone else with access to key company information before it's made available to the public. Savvy investors, making the reasonable assumption that insiders know a lot more about their company's prospects than the rest of us, pay close attention to what insiders do with company shares. And, because insider ownership and trading can impact share prices, the Securities and Exchange Commission (SEC) requires companies to file reports on these matters, giving investors the opportunity to have some insight into insider activity.
(For further information on insiders, see Defining Illegal Insider Trading and Uncovering Insider Trading.)


The Forms
You can retrieve reporting forms from the SEC's EDGAR database or the SEC Info Insider Trading Reports. Form 14A is the proxy statement in which you will find a list of directors and officers and the number of shares they each own. There is also a list of beneficial owners, or people or entities owning more than 5% of a company's stock.

The other relevant forms are 13D and 13G for disclosure of outside beneficial ownership, and Forms 3, 4 and 5 for disclosure of insider beneficial ownership. Insiders with more than 10% of the voting power file Forms 3, 4 or 5, and outsiders owning more than 5% file schedule 13D or its amendment form 13F.

Individuals file Form 3 when first acquiring shares, Form 4 to report changes, and Form 5 as an annual snapshot of holdings. Insider trading must be filed electronically through the Edgar system within two days of the transaction, giving outside investors reasonably up-to-date ownership information.


Interpreting Insider Reports

High inside ownership typically signals confidence in the company's prospects, and the ownership in its shares in turn gives management an incentive to make the company profitable and maximize shareholder value. Indeed, academic research has shown that firms with significant insider purchasing tend to outperform the market indexes.

On the other hand, you can have too much insider ownership. When insiders gain corporate control, management may not feel responsible to shareholders. This occurs frequently at companies with multiple classes of stock, which means one class carries more voting power than another. For example, Google's much publicized IPO in the fall of 2004 was criticized for issuing a special class of "super voting shares" to certain company executives. Critics of the dual-class share structure contend that, should managers yield less than satisfactory results, they are less likely to be replaced because they possess 10 times the voting power of normal shareholders. (Read more in The Two Sides of Dual-Class Shares.)

While insider buying is usually a good sign, don't be alarmed by insider selling, unless there is a lot of it - insiders tend to buy because they have positive expectations, but they may sell for reasons independent of their expectations for the company.

Look for clusters of activity by several insiders. If a company has more than one insider trading similarly over a short period, there's a sign of a consensus of insider opinion. Also, large transactions mean more than small trades.

It's important to know which insiders to watch. Insiders with proven track records with their Form 4 activity should be watched more closely than those with little or poor past records. The most telling trading activity comes from top executives with the best insights into the company, so look for transactions by CEOs and CFOs.

Finally, be careful about placing too much stake in insider trading since the documents reporting them can be hard to interpret. A lot of Form 4 trades do not represent buying and selling that relate to future stock performance. The exercise of stock options, for instance, shows up as both a buy and a sell on Form 4 documents, so it is a dubious signal to follow. Automatic trading is another activity that is hard to interpret - to protect themselves from lawsuits, insiders set up guidelines for buying and selling, and leave the execution to someone else. SEC Form 4 documents disclose these hands-off insider transactions, but they don't always state that the sales were scheduled far ahead of time.


Institutional Ownership

Organizations controlling a lot of money - mutual funds, pension funds or insurance companies - buying securities are referred to as institutional investors.


The Debate over the Implications
Whether institutional ownership in a stock is a good thing remains a matter of debate. Peter Lynch, in his best-seller "One Up on Wall Street" lists the 13 characteristics of the perfect stock. One of them is this: "Institutions don't own it and the analysts don't follow it". Lynch favors stocks that the big investment groups overlook because these stocks have more of a chance of being undervalued. Lynch argues that companies whose stock is owned by institutional investors are fairly valued, if not overvalued.

William O'Neil, founder of Investor's Business Daily, on the other hand, argues that it takes a significant amount of demand to move a share price up, and the largest source of demand for stocks are institutional investors. O'Neil reckons that if a stock has no institutional owners, it's because they have already seen it and rejected it. In his book "How to Make Money in Stocks", O'Neil has institutional sponsorship as the sixth characteristic to look for in stocks worth buying.

O'Neil and Lynch, however, both agree that institutional ownership can be dangerous. These big institutions move in and out of positions in very large blocks, so they cannot buy or sell holdings gracefully. If something goes wrong with a company and all its big owners sell en masse, the stock's value will plunge.

Although there are mutual funds that operate with longer-term horizons, and pension funds tend to be long-term stockholders, institutional investors tend to react to short-term events. The high correlation between high institutional ownership and stock price volatility is a fact of life in investing. So, it pays to know what the institutions are up to and whether a stock you are interested in already has a large institutional interest.


Where to Find the Information

Institutional investment managers who exercise investment discretion of more than $100 million in securities must report their holdings on Form 13F with the SEC. Again, you can search for and retrieve Form 13F filings using the SEC's EDGAR database. To find the filings of a particular money manager, use the search entitled "Companies & Other Filers", go to"General Purpose Searches" and enter the money manager's name.

MSN Money also provides a very useful site that details stock ownership. Go to the Institutional Ownership link and type in the stock code of a particular company to receive details on the company's institutional holders.


Conclusion

Sure, insiders and institutions tend to be smart, diligent and sophisticated investors, so their ownership is a good criterion for a first screen in your research or a reliable confirmation of your analysis of a stock. But never base an investment decision solely on insider or institutional ownership information.

For further reading on this subject, see When Insiders Buy, Should You Join Them? and Can Insiders Help You Make Better Trades?.

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