Insider Buying Reaches a 10-Year High

In an article published on March 25, I discussed how investors can learn from Exxon Mobil Corporation (XOM, Financial) insiders and went on to analyze the company's fundamentals to conclude that Exxon is significantly undervalued.

A quick look at the activity of insiders in the last 30 days gives reason to believe that company executives are betting on the respective companies they represent like never before. This could be an indication of the equity market performance in the coming years. The subject of this analysis is to interpret the current trend of insider buying and selling using empirical evidence.

Insider buying reaches a 10-year high

The recent market decline was triggered as a result of the outbreak of the Covid-19 virus and the oil price war between Saudi Arabia and Russia. This has pushed many investors on to the sidelines, even though many gurus, including Warren Buffett (Trades, Portfolio) and Bill Ackman (Trades, Portfolio), are already hunting for bargains.

Corporate insiders have joined the buying party as well. According to data from CNBC, the insider buy-sell ratio reached 1.75 on March 27, the highest reported level since 2009.

Source: CNBC

Washington Service, the company that is responsible for collecting and publishing this data, claims that this ratio typically stays below 1, meaning company executives are net sellers of the shares of companies they work for. This is understandable, as top-level employees receive stock grants through options for achieving targets, which are sold in the open market to convert them to cash.

Nejat Seyhun, a finance professor at the University of Michigan who has studied insider activity for many decades, was contacted by the Wall Street Journal on March 27 for his opinion. Commenting on the recent trend, Nejat said:

“Insiders think the market downturn is going to be temporary – they don’t think this is going to be a permanent dent. China solved the coronavirus problem, South Korea solved the problem, and they already showed us what to do to solve the problem.”

This is not the first time insiders have aggressively invested in shares of the companies they work for. For instance, before the dot-com bubble burst in 2001, corporate executives were aggressively investing in the shares of their companies. During 1998, such investments reached a peak. However, most of these executives realized massive losses when the stock market crashed a few years later.

Source: The Wall Street Journal

These mixed results might make it difficult for investors to decide on whether to follow the lead given by insiders today or to ignore it altogether in fear of a further decline in stock prices.

Valuation multiples look much better

The Shiller price-earnings ratio is one of the most popular indicators of broad market valuation. In mid-2018, this multiple reached highs which were previously seen before the Great Depression of 1929.

Source: GuruFocus

However, the recent market decline is once again pulling back the ratio toward its historical average of around 17, which is an encouraging sign for investors. The decision by insiders to bank on this opportunity seems rational considering this improvement in valuation levels. As illustrated in the above chart, when executives aggressively bought shares in 1998, the Shiller price-earnings ratio was at a historic high, but things are different at present.

InsiderScore director of research Ben Silverman considers this current buying trend as one of the strongest signals for the possibility of a market recovery within the next few months. In a note to investors, Silverman wrote:

“Insiders have a 35+ year track record of buying on the type of extreme weakness experienced in Q1 2020. A dramatic increase in insider buying volume combined with dampened levels of insider selling has resulted in the generation of industry buy inflections – our strongest quantitative macro signal – for the entire market.”

Do insiders have an edge over others?

Company executives might not be experts in picking stocks, which is evident from the mistakes they committed in 1998. However, there’s no denying that these professionals are better positioned than the rest of the market to identify the developing trends about corporate earnings for their own companies. Their first-hand experience in executing expansion plans and the cash flow projections associated with such investments provide them an advantage over retail investors.

This, however, does not always guarantee attractive returns from investments. A piece of popular advice given by Warren Buffett (Trades, Portfolio) illustrates this:

“Long ago, Benjamin Graham taught me that price is what you pay, value is what you get. Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

This is exactly the type of advice that insiders should listen to, in my opinion. Despite their superior understanding of the prospects of the companies they represent, they might end up paying a premium price to buy the shares, which eventually leads to disappointing investment returns.

Therefore, an investor should be careful in following the lead given by insiders. However, ignoring it altogether is not a wise decision either. Striking a balance between the two and applying an adequate level of due diligence is the correct way forward.

A few companies to consider

A few notable executives are loading up on shares of their companies. Some of these transactions are listed in the below table

Source: Company filings

Most of these companies have shed more than 40% of their market value since reaching a peak in mid-February. The insider investments of energy company executives stand out in particular because of the significant decline in the crude oil price. This is a clear indication that executives are hopeful of an agreement between Saudi Arabia and Russia to put an end to the oil price war.

The banking sector, on the other hand, is poised to come under pressure in the future as a result of historically low interest rates. Therefore, analyzing financial services sector stocks could be tricky in comparison to energy or tech companies that are likely to recover along with a resumption of global economic growth.

Takeaway

Even though corporate executives have had mixed results in the past, I believe they are most likely to come out as winners this time around. Valuation multiples of many billion-dollar companies have contracted as a result of the increased market volatility, which would most likely be limited to a couple of months.

Pandemic worries are unlikely to have an extended impact on the world economy. China has already contained the spread of the virus, which is a positive sign. Carefully analyzing insider buying trends and investing in companies that are trading at attractive valuation levels could lead to attractive returns. The GuruFocus Insider Trades feature is a useful tool for investors to screen for such companies.

Read more here:

• Carl Icahn Gets What He Wants From Occidental Petroleum
• Bill Ackman Goes Long on Starbucks
• Exxon Mobil: Learning Boldness From Insiders

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