Peter Lynch once famously said that "insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise." Watching what insiders are buying is a great way to generate investment ideas.
But investors need to be aware that not all insiders are created equal. Some companies’ CEO, CFO and directors are much more rational than others. When generating ideas from insider trades, it is important to look at the track record of the insiders.
Consider the insider buys at Wal-Mart (NYSE:WMT). Large trunks of insider buying activities were observed in the years from 2008 to 2010, when the giant retailer’s stock was traded at decade lows of around $50 and historical low valuations. Wal-Mart directors James Breyer and Aida Alvarez, vice Chairman Michael Duke, etc., kept buying shares. These shares have since appreciated 50%, and Wal-Mart stock is now making all-time highs.
This is the insider trade history of Wal-Mart:
If buying Wal-Mart following its directors has been profitable, it can other times be disastrous to following insider buying blindly, even if it is the company’s CEO. A high profile example here is Chesapeake Energy (NYSE:CHK). The company’s CEO Aubrey McClendon continued to buy Chesapeake stocks in his own account as the stock prices ran up from the $30s to $50s before the financial crisis, on margin! By October 2008, he had accumulated more than 32 million shares, which was valued at more than $2 billion at the peak of the stock price. Then the stock market collapsed, and he got a margin call and has had to sell almost all of the shares at an average of $18 each. He lost billions with his purchases. Now Chesapeake stock is traded at $18 and change. He is buying aggressively again:
If you plan to follow him into Chesaspeake, make sure you are aware of what happened before.
A few years back, Wal-Mart management received complaints for poor stock performance since 2000. The management argued correctly that since Wal-Mart was traded at P/E ratios in the 40s in the year 2000, it was unlikely to do well for those who bought back then. But over the last decade, Wal-Mart continued to grow while its stock price declined. The P/E ratio of the stock declined from the 40s to 13. For a company that grows its EPS very predictably at 10%, it was cheap. The smart insiders started to buy. Many of our gurus started to buy. Now Wal-Mart is at its all-time high. Those buying the high quality company at fair prices and patiently waiting are rewarded.
Over the long term, Mr. Market is quite fair, isn’t he?
- Can Aggregated Insider Trading Activities Predict the Market?
- Stocks that Both Gurus and Insiders are Buying
- Can Aggregated Insider Trading Activities Predict the Market of Different Sectors?
- CEO Buys, CFO Buys: Stocks that are bought by their CEO/CFOs.
- Insider Cluster Buys: Stocks that multiple company officers and directors have bought.
- Double Buys:: Companies that both Gurus and Insiders are buying
- Triple Buys: Companies that both Gurus and Insiders are buying, and Company is buying back.