Investing: Profiting from Insider Moves
Yet all is not dark. Michael Painchaud has been following insider transactions for 32 years, 19 of them at his Seattle investment research firm, Market Profile Theorems. Painchaud says that while selling has picked up, it has been worse. "The selling is still not nearly as high as it was when the market was near its peak at the end of 2007," he says. (Although only institutional investors have access to Painchaud's research and recommendations, individual investors can follow insider trades free of charge at sites such as Yahoo! Finance (YHOO) and Morningstar.com (MORN).)
SEEING PROMISE IN AIR TRAVELPainchaud says he thinks there are still attractive insider opportunities—only you have to work a little harder to find them. He notes that stocks in the air transportation industry, including Air Transport Services Group (ATSG) and Dynamex (DDMX), have recently seen an uptick in insider purchases. "The entire air travel industry has been in the tank lately, and no one is expecting it to do well," he says. "But the insiders are buying." There are pockets of opportunity in other sectors. InsiderScore's Web site ranks companies from very positive to very negative based on insider transactions. One example: While Painchaud says sentiment on energy stocks has turned negative in recent months, InsiderScore has a very positive ranking on McMoRan Exploration, an oil and gas producer drilling in the Gulf of Mexico. The company's two co-chairmen bought $5.5 million in stock at 5.75 a share on June 17.
Still, most professional investors would only use such insider info as part of their overall analysis of a company. "I do not advocate buying any stock based solely on insider data," says Jonathan More land, director of research at InsiderInsights, an online investment newsletter. "It's a wonderful first screen to be followed by fundamental analysis." In fact, research that the University of Michigan's Seyhun has conducted reveals that a strategy taking into account both strong insider buying and traditional valuation metrics such as low price-to-book-value ratios and low price-to-earnings ratios increases returns more than either strategy would alone.
Moreland's newsletter portfolio of insider picks has beaten the market by a wide margin since the publication's 2001 launch, and is up 17% year-to-date. He layers valuation metrics and research on top of insider purchases when evaluating stocks. McMoRan pops up on his screen too, thanks to its low 3.2 price-to-cash-flow ratio and research that Moreland says shows the company has good prospects for making significant oil and gas finds. He also runs a special screen every week of companies worthy of further research based on insider buying and low valuations. Two such firms are International Bancshares (IBOC) of Laredo, Tex., and First Community Bancshares (FCBC) of Bluefield, Va., both of which have suffered during the mortgage crisis. They trade below book value, which is the value of their underlying assets.
It is precisely at such troubled companies that insider data often prove most useful to value investors. "For value managers, insider buying is a form of confirmation," says John Spears, co-manager of the Tweedy Browne Global Value Fund. (TBGVX) "It's often [positive to see buying] in companies where there's a controversy such as a lawsuit, something hard for us outsiders to grapple with." By contrast, seeing insider sales at companies that are cheap is a red flag. "Insiders sell for all kinds of reasons, but if a stock has been hammered and insiders are still selling right and left, it's a warning sign," Spears says.
There are plenty more insider-hoisted red flags today. Painchaud points to building materials outfits such as Martin Marietta Materials (MLM) and U.S. Lime & Minerals (USLM). He's also finding sales in health care (Athenahealth (ATHN), Biogen Idec (BIIB), and MedAssets (MDAS) and finance (Financial Federal (FIF), RiskMetrics Group (RMG), and World Acceptance (WRLD). InsiderInsights' Moreland doesn't like Alexandria Real Estate Equities (ARE), a real estate investment trust that has declined 62% in the past year—yet insiders are still selling. He recommends shorting the stock. All of which goes to show that even if the market declines, there may be ways to profit from watching the insiders.