Watching To See What The In Crowd DoesPam Black
Who knows a company's prospects better than the people who run it? Whether or not the higher-ups are buying or selling their stock can be a clue about the future of a company, an industry, even the overall market. Although you can't rely on insider activity alone, it can be useful if you know how to read the tea leaves.
Insider buying is fairly straightforward to interpret. New directors and managers often acquire a handful of shares simply to show they're on the company team. Seasoned executives will buy because they're bullish. So if a new manager buys 1,000 shares, it doesn't mean much--compared with an executive's buying a year's salary worth of stock, says Neil Rudolf, chief operating officer of Insiders Select Portfolio, a new Bear Stearns fund that uses insider activity in its stock-picking strategy.
IBM SLIDE. A decisive buy signal often comes when, after persistently selling as a stock drops, insiders start accumulating shares. IBM is a classic example. When the stock slid from the $80 range to the $40s between September, 1992, and June, 1993, "there were lots of highly thought-of people on the Street who thought the stock would fall further, to $30," says Michael Painchaud, director of research at Market Profile Theorems, a Seattle investment-advisory firm that follows insider behavior. "But there was aggressive insider buying in the $40 range." Continued buying by insiders as the stock moved up provided confirmation of the initial bullish sign. It now trades at 1091/4.
Such activity can separate out the good buys at yearend, when stocks in general are down--because that's when investors are selling losers for tax purposes. The trick is to figure out which stocks deserve to be down and which are merely pushed down by yearend selling, says Bob Gabele, whose company, CDA/Investnet, compiles data on insider trades. "Where there's significant insider buying, those are the best candidates for bounces."
But to gauge significance, you must know who's buying, in what quantity, and at what price. A vice-president sinking the equivalent of his salary into the company is a stronger signal than a chairman with millions in stock buying a few thousand shares. Likewise on the sell side. Bill Gates may dump lots of Microsoft, but "even if he sold a million shares a quarter, it would take him years to make a dent in his holdings," says Praveen Gottipalli, fund manager of Insiders Select Portfolio.
MORE THAN ONE. It also helps to know an insider's track record. A person who buys indiscriminately is less valuable to follow than a "smart insider," someone with a history of buying at lows and selling at highs. Gabele points to Holcombe Green Jr., a director at Georgia Gulf. He bought aggressively in 1990 at 6 to 9 and sold steadily over the next few years at 17 to 26. Therefore, his latest buy seems very bullish: 57,000 shares at 335/8 in May. "He made a $1.9 million commitment. After selling at $25, that's pretty impressive," says Gabele.
One insider isn't enough. Ideally, you would look for at least three of them purchasing more than 10,000 shares apiece in a 30-day period, advises Market Profile's Painchaud. It's an even better clue when insiders buy across a given industry. In 1989 and 1990, when everyone thought banks were melting down, insiders were eagerly buying. You also have to consider the price: If they purchase at 10 and you don't hear about it until the stock is 15, don't jump. Wait to see if they strengthen that signal by buying again at 15.
Insider selling is harder to read than buying, because there are so many reasons for it. Executives may be raising money to buy a house, diversifying their portfolios, or simply retiring. And since many directors and top managers get paid in stock options, it's common to see some selling a few years after a company goes public--their first chance to raise cash.
"BOUNCE." But when insiders sell a stock as it drops, says Gabele, "that's a clear-cut sign to me that I don't want to buy." Take Chipcom, a maker of local-area networks. After peaking at 50 last December, the stock dropped slowly this spring to the low 30s. Insiders uere selling all along--a total of 47,000 shares. "When the stock is close to its 12-month low, and insiders aren't waiting for it to bounce back, chances are it won't," says Gabele. Chipcom later announced IBM would cut its orders, and the stock confirmed the insider activity by dropping to 20.
What insiders do with their options is equally important. If they exercise the options to buy the underlying stock and sell it at a small profit, that may mean they're cashing out at the best price they think they can get. Acuson, a maker of ultrasound equipment, had been selling in the 30 to 40 range. By last fall, it had dropped to 14. Insiders were exercising options at 111/2 and selling at 14 even though the options weren't expiring, says Gabele. The stock later fell to the 11 to 12 range.
It can be bullish when executives exercise options but hold the stock. Sybase peaked in January at 55. A month later, it dropped to the mid 40s, and five insiders dumped a total of 229,000 shares. In April, Sybase announced a small earnings disappointment, and the stock fell to the low 20s. Then director Michael Kertzman exercised options for 200,000 shares and held the stock. Two other insiders were exercising and holding, and three others were buying small blocks. "That was a good value indication: Six people accumulating stock in the low 21 range," says Gabele. Sybase later rallied to 35.
Also, what looks like a sale may really be a buy. Cirrus Logic's president sold 5,000 shares in February. Meanwhile, he exercised options for an additional 60,000. "If you were only looking at buys and sells, you would see a 5,000-share sale, but in effect the president had picked up 55,000 shares," says Gabele. "You have to look at net effect."
It may be hardest to interpret when insiders are selling as the stock price rises. They obviously want to take profits. But that doesn't necessarily mean the stock has peaked. For example, insiders in the semiconductor industry did their heaviest selling in 1992 and 1993. But the sector still continued to soar.
That's why it's usually not possible to use insiders to time short-term swings. "Insiders aren't good at timing," says Gabele. "They are good at indicating valuation." They're more likely to buy when the stock is a bargain and sell when it's overpriced. But insider activity can presage broad market moves. Trackers look at a ratio of sells to buys. A neutral ratio is around 2.25 sells to 1 buy, says David Coleman, who publishes Vickers Weekly Insider Report. Anything below that tends to be bullish. In 1994, lots of buying sent the ratio down to 0.8. But in recent months, buying has dropped precipitously, says Coleman, and the ratio, now about 2.24, is neutral and possibly poised to turn bearish.
The bottom line: When it comes to insider activity, the context is everything. "Using it alone is like a blind person trying to discern what an elephant is with one touch," says Market Profile's Painchaud. He relies on several proprietary data models, along with insider trading, to advise institutional clients. Insiders Select Portfolio uses Gabele's insider data, analyst reports, and corporate fundamentals. Even when the insider activity is pointing to a sure bet, you shouldn't buy a stock that doesn't fit with your investment goals, says Gabele.
Remember, don't just follow the lone insider. If an insider says he is selling to pay for his daughter's wedding, no problem, says Gabele. But if six insiders tell you their daughters are getting married, the company may be in trouble.
The Insider Scoop
BUYING A recent hire who buys shares may just be showing solidarity for the corporate team. But if longtime executives snatch up shares simultaneously, that's usually a sign the stock is trading at a good value.
If the stock price has been dropping and insiders suddenly start buying, they're probably anticipating a turnaround and want to get in at the bottom.
SELLING An insider might unload a big block of shares for any number of personal reasons--to raise cash for a new house or diversify a portfolio. But if several insiders sell as the stock is falling, that's often a sign of bad news ahead.
Insiders who sell when the stock is rising might be taking profits. But they're not necessarily any better at timing peaks than other investors. So you might simply want to monitor the situation.
EXERCISING OPTIONS When insiders cash in options and sell at a slight profit, they may think the stock is on its way down. When they exercise a lot of options and hold on to the stock, they're often expecting a rise.
DATA: BUSINESS WEEK
Where To Find Insider Facts
(800 243-2324) publishes a weekly newsletter, Insiders' Chronicle ($375 a year). Or you can tap into its data-base by computer ($2 a minute).
(800 442-9000), a biweekly newsletter, identifies trading patterns and makes buy and sell recommendations ($49 charter price, then $100 a year).
THE WASHINGTON SERVICE (202 778-1380) provides access to its database, with daily trades by company ($235 a month). Historical data- base ($350 a month).
VICKERS WEEKLY INSIDER REPORT
(800 645-5043) lists all insider trades of more than $500 and includes a model port-folio ($176 a year).
DATA: BUSINESS WEEK
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