Insider Buying: Look Before You Leap

Executives at outfits such as First Horizon National and Advanced Micro Devices have been buying stock, but investors shouldn't follow blindly

It's time to grow up about insider selling. The words still can't escape a whiff of impropriety. While insider selling might be considered a sign of bad faith, analysts say it's natural for major stakeholders to sell off chunks of their holdings when the market runs up as it has in recent months. And there's not much for small investors to learn when a mega holder sells a chuck of stock.

Even when the dollar amount is substantial, it doesn't necessarily add up to a worrisome part of their stake. For example, Bill Gates sold hundreds of millions of dollars worth of Microsoft (MSFT) stock in November but still holds hundreds of millions of shares. That doesn't say much. Like everyone else, top executives want a diverse portfolio.

Now that major equity indexes like the S&P 500 have made impressive strides, a stat that could be more valuable is insider buying. Who wouldn't want to invest in a company where top execs are betting on themselves on the open market?

Less Weight asked InsiderScore, a research outfit that studies insider transactions, to find out which companies have optimistic insiders, a potentially strong sign for investors. The firm weighed the value of shares purchased against those sold to calculate an insider buying score for each company. A company's score gives unique weight to different types of sales. Relatively small, planned divestments, for example, carry less weight because they're not a reaction to specific news.

As one might expect, InsiderScore finds that insider selling has increased as the market has risen in recent months. That's usually the case, but in this bull market there hasn't been a net positive insider buying score since mid-August.

Still, some level of buying has continued. "There are a lot of investors who overvalue the impact of selling," says InsiderScore principal Rusty Szurek. "If I'm an investor, I would care more about buying activity."

Since one large transaction can determine a company's score, insider buying isn't the only things investors should track. Take First Horizon National (FHN), a Memphis bank with the highest insider buying score for the past three months among companies with a market capitalization of more than $500 million. Most of the activity comes from Director R. Brad Martin, who is also chairman of upscale retailer Saks (SKS).

Scattershot Purchases

Jaime Peters, an analyst at Morningstar, says the showing reflects both a time when Martin had the cash flow to pour into First Horizon stock and the director's "belief that this company is undervalued." For her own part, Peters gives the company five stars, the only stock out of the 30 she follows with that highest rating. While the company's mortgage and securities businesses can be more volatile, she writes, "it's the company's traditional banking business that gets us all warm and fuzzy inside."

Szurek says certain traits can make tracking apparently scattershot insider purchases more profitable. The higher-ranking the insider, the more likely it is to be important. Investors should also consider the "conviction factor"—the size of a transaction relative to an insider's holdings.

"Buying on strength is a more notable event for the long-term performance of a stock," Szurek says. If company brass is buying while the stock is climbing, it could be a strong indicator that the stock hasn't peaked.

Of those companies that have recently seen insider buying, he finds microprocessor outfit Advanced Micro Devices (AMD) promising. One tipoff to investors is that several insiders have recently made purchases. On the downside, planned community group WCI Communities (WCI) has had insiders buying, but that hasn't always translated into strong gains for the stock.

Indicator of Strength?

Likewise, Pep Boys (PBY), the Philadelphia-based auto parts and service chain, has among the highest scores for insider buying over the past 3 and 12 months, but this hasn't convinced analysts that the stock is a buy. It faces tough competition and operating inefficiencies. Rating the stock a sell, a recent Standard & Poor's report says that a successful turnaround will take years.

Morgan Joseph analyst Jeff Blaeser is more bullish on Pep Boys. Among the advantages he sees, and the inside buyers perhaps share, is the potential for the company to rebound. He also thinks its extensive real estate holdings may be undervalued. Still, it remains far from clear that insider buying is an indicator of strength to come in this case. (Morgan Joseph seeks banking relationships with those companies on its coverage rolls.)

Just because top execs thinks their stock is about to make a move, it doesn't mean they're right. Some other outfits that InsiderScore found have recently had high insider buying activity include Revlon (REV), Cenveo (CVO), and Viacom (VIA). It's quite a mix. That's why investors shouldn't buy or sell a stock based on insider moves alone, because other forces are often at work.

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