Mar

30

When I first started studying stocks and insider trading, I got a cold call from a broker touting a medical stock saying insiders were buying. A little research showed that all the executives got company large loans to buy stock, and the company was in trouble, right before they faced bankruptcy.

Then Indiana's biggest insurance company at the time through rapid acquisition, Conseco, CEO and Board, also seemed to buy just before any big announcement. But again, they got big loans to buy stock right when they got in trouble buying the mobile home lenders. I believe it was Greentree Financials, the first "big" financial failure due subprime 10 years before the crisis of the "big" financials, who were smarter than everybody else.

After these 2 experiences, one wonders, if this is a "hail mary" signal. When the board wants insiders to buy a synthetic call (buying the stock, in effect shorting their bonds by taking a loan), do the stock and their bonds underperform?

Any studies on this?

Henrik Andersson writes: 

The firm I work for just launched a product following insider transactions and the track record per insider for Sweden. The product was first back tested. Part of the conclusion for that back test were:

After studying over 140,000 insider transactions over the past 12 years in Sweden, we conclude that following insiders leads to excess returns on average, confirming the results of numerous academic studies. However, not all insiders were created equally: some company insiders have a much higher "hit ratio". Our analysis also confirms the limited value of sell transactions for generating excess returns on an individual stock basis, although the volume of insider selling on aggregate can be a useful alarm bell for market moves. Our analysis of Swedish insider transactions shows that insiders have on average earned an excess return on share purchases of 3.2%, 5.5% and 13.3% for 3, 6 and 12-month holding periods respectively. Insider purchases outperform the market 55% of the time, but there are large deviations in this "hit ratio" by company.

The log normal distribution of the returns of the insiders look normal but with the average return beating the market.


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2 Comments so far

  1. Craig on March 31, 2012 7:09 am

    Sweden’s Per Holmlund wrote a book that included examples of insider selling while corporate buybacks supported the price. Citigroup did this around 2006 and 2007. This isn’t illegal but it should be. Bank of New York insiders (especially the CFO) used to be interesting to watch as they were really dumping in 1999-2000. I pointed this out to the girl that produced their actual financial reports. She said she didn’t care and was buying more anyway.

  2. john smith on April 3, 2012 12:15 pm

    http://www.amazon.com/Investment-Intelligence-Insider-Trading-Seyhun/dp/0262692341/ref=sr_1_1?s=books&ie=UTF8&qid=1333468835&sr=1-1

    Some insights from Seyhun’s book:

    Insider buying is a potential signal, however you should be careful. The first thing, identify what type of insiders are actually buying (big stockholders or directors, executives, top level executives). Identify sales-to-buys ratio. Since we know, typically executives are granted some stocks and options as a part of the compensation package, in a typical public company selling is twice as frequent as buying (ratio= 2:1). If it gets more even, or buying outnumbers selling it is likely to be a positive sign. However, you should know, there is no real benefit to mimicking insiders in short term, according to evidence, the returns usually start kicking in after 1 year.

    In practice, this is never easy because of the large number of transactions and can be quite confusing with a lot of mixed signals.

    I would advise anyone not to buy in small companies and even less on a piece of advice from a broker who typically has a great incentive to trick some customers only to get commission and/or a juicy spread.

    Finally, don’t rely only on insider buying to make your decision, try finding out about the firm, a-la Fisher. Scuttlebutt method works great. If a company is in trouble you will be able to find out from competitors, ex employees or industry analysts.

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