Learning how to assess the characteristics of insider buying, will improve one's chances of investment success.
First, the quantity of insider buying is important. The amount of net shares bought should be evaluated relative to the insider's personal shareholdings or the company's shares outstanding, to determine if the quantity of insider buying is considered significant. Also, more than one insider buying shares is better than putting faith with a lone ranger.
Second, the quality of insider buying also matters. Insiders refer to directors, officers or owners of more than 10% of a class of equity securities. Executive directors and management should have more insight into a company's operations than non-executive directors and institutional shareholders, since they are involved with the day-to-day running of the company. Purchases by executive directors and management should be given more attention than those of non-executive directors and institutional shareholders. Conflicting signals such as insider purchases by one group and sales by another group should be noted.
Last but not least, the intention behind insider buying needs to be assessed. Insiders purchases via exercise of options are less positive than those via open market purchases. Insiders who purchase shares using options, are typically buying shares at prices significantly below market prices and could be looking to cash out at current market prices in the short term. Also, the history of insider buying needs to be examined. An insider, who sold shares previously because of personal financial difficulties, may be just reinstating his earlier shareholding levels with recent purchases. In cases where the company faces the risk of a change of control via a hostile takeover, the controlling shareholder could be adding to his position to deter the possibility of a takeover.
However, one should not put the cart before the horse. Strong insider buying represents the icing on the cake for a stock with sound fundamentals and attractive valuations. Investors should not screen for stocks with strong insider buying first and subsequently build investment cases for the stocks with an inherent bias.