Insider buying and selling data can be extremely valuable for the individual investor. That is, if one knows how to use that data and interpret it so that a meaningful investment decision can be made.
Insiders (executives and beneficial owners) must file what is called a Form 4 with the Securities and Exchange Commission (SEC). The form essentially outlines the date and price at which a given executive has completed a large transaction in a stock. This data is then used by the investment community as a gauge of insider sentiment.
But what specifically should an investor look for in this information and what should be ignored? Here we'll provide some guidelines for interpreting insider data.
There are many reasons why an insider might sell a stock. The person may be buying a house, have an immediate cash need, or simply be looking to diversify his or her portfolio, which may be heavily tied to the share price. All are legitimate reasons to sell. Therefore, investors should not assume that if an officer of a public company is selling his or her stock that it's a sign shares might be headed for a fall. In fact, the contrary may actually be true. (For more on this, read Insider Selling Isn't Always A Bad Sign.)
Therefore, especially when it comes to insider selling, investors should look for clusters, meaning groups of two, but preferably three or more insiders doing the same thing in order to identify a pattern. That said, on the buy side clusters aren't as important. That's because there is usually only one reason an insider might purchase stock: to make money. (For further reading, check out When Insiders Buy, Should Investors Join Them?)
So, on the buy side, look for individual purchases that are meaningful. A 100-share purchase of a stock probably isn't worth drawing any conclusions from, but if an exec is buying 1,000 shares (at $20 a share), it probably warrants a bit more attention.
Also, consider what, if any, stock the insider holds in aggregate after the transaction is completed. In other words, if the exec sells 1,000 shares but continues to hold another 100,000, shares, this should not be construed as a negative sign. On the flip side, if an exec buys 1,000 shares and he or she already owns 100,000, it is a bullish signal, but certainly not one to write home about.
Diversity in Transactions
Remember that every exec has a different view of the company's future, so look for buying or selling from division heads. Look for the vice president of sales to step up to the plate, or the director of research in addition to the CEO and/or the CFO. After all, if these front-line individuals are buying the stock en masse, it might be logical to assume that the company is headed for better times. Conversely, the opposite may be true if these individuals are selling the shares. (For more on this, see Evaluating A Company's Management.)
Relate Back to the Proxy
When trying to determine whether insider buying or selling is significant, it may help to determine the transaction cost or proceeds, and then put them in perspective to the officer's current holdings. Another suggestion is to look at the transaction in comparison to the officer's annual salary and then determine whether the transaction is noteworthy. Salary information can be found in the company's proxy statement, which is available on the SEC's website. (For more on this research, see Pay Attention To The Proxy Statement and Evaluating Executive Compensation.)
As an example, if an insider is buying $30,000 worth of stock and makes $150,000 a year, that says a lot! But if the purchase totals $1,000, it obviously does not imply the same level of bullishness. The same example is true on the sell side.
As part of their salaries, senior executives often receive stock options. These options may be exercised at a point in the future and then converted to common shares, which may then be held or sold.
Look to see whether insiders are holding the stock after the exercise, or if they are selling. Keep in mind that selling isn't necessarily bad, because a sizable portion of an executive's net worth may be tied up in the stock. But again, check out the proportion of the transaction compared to the executive's salary and the size of his or her holdings. If insiders continue to hold the shares after the exercise, it is usually a great sign that better times may lie ahead. (To learn about stock options, read The Controversy Over Option Compensation.)
Transactions at Extremes
Are insiders buying or selling at or near the 52-week high or the low? Insider selling near the lows is an extremely bearish signal. Think about it. If you were an insider and your stock had already taken a beating, wouldn't you want to hold onto the shares if you thought that a rebound was likely?
Along those same lines, insider buying near the highs is usually an extremely bullish sign, suggesting that insiders believe that new highs are a distinct possibility.
Insider data should always be used to compliment the research process, never in lieu of it. Insider data can be an extremely useful tool if you know what to look for, and what conclusions can and cannot be extrapolated from it. So consider the above suggestions - they will only serve to enhance the research process and to help you to make more intelligent investment decisions, particularly when it comes to entry and exit points in a stock.