Aug

18

 Throughout Wall Street history, insiders have earned superior returns on purchases and sales of their companies' stocks. H. Neyjat Seyhun wrote a book in 1998, "Investment Intelligence from Insider Trading", detailing an exhaustive study of insider transactions. Seyhun found that stocks in which insiders were net buyers outperformed stocks in which insiders were net sellers by an average of 8% in the following 12 months.

The Wall Street Journal is well aware of this outperformance and regularly reports on insider transactions. I was quite surprised, therefore, by today's Heard on the Street column. David Reilly suggests that investors would be foolish to follow the lead of financial company executives, whose net purchases of their companies' shares in July were the highest in 10 years.

Excerpt : [subscription required for link to full article].

"Company executives clearly have better information than the average investor. But it doesn't always pay to follow their buying cues.

Like plenty of other investors, executives at financial firms haven't been good at calling bottoms during the credit crunch. In the third quarter of 2007, executives and directors of diversified financial companies — brokers, big banks and exchange operators, among others — bought more stock in their own companies than at any other time since the third quarter of 2002, according to data from Gradient Analytics.

The trade didn't work. The third quarter of 2007 was anything but the bottom for financial stocks …

Today, financial executives are back buying. Since the end of June, the value of purchases, when compared with share sales, has reached its highest level in a decade."

Kim Zussman replies:

It would seem difficult to believe in changing cycles (dissipation of knowable patterns), and not suspect that insider buying has been gamed - by insiders who are informed of the literature and seek (for not unselfish reasons) to align with shareholder objectives.

Whether Seyhun's alpha persists will be answered in time, but like others which are well-known, expect it to run through a period of great disfavor before flying again.

Victor Niederhoffer comments:

It's ridiculous to assume that because in one quarter insiders were wrong, this disproves studies based on hundreds of thousands of trades. Of course it doesn't work, some quarters — like the beaten favorite Federer: that's when he's going to win the doubles for sure.

[Dr. Niederhoffer is the author of "Predictive and Statistical Properties of Insider Trading", The Journal of Law and Economics XI (April 1968): 35-53.]


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2 Comments so far

  1. Greg Vinately on August 19, 2008 8:12 am

    Call it a ridiculous coincidence that insiders in housing companies were selling record amounts of stock just prior to the big implosion. Apparently most CEOs argued at the time that the sales were for “diversification” purposes.

  2. Matt Johnson on September 9, 2008 8:49 pm

    Roger Federer is so great — the US Open win makes 13!

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