More than a year ago, I published an article titled "Piggybacking The Gurus Intelligently"Â on GuruFocus, where I highlighted several factors that investors should take into account while mimicking the trades of their favorite superinvestors using 13F filings.
I would like to continue where I left off, by focusing on another category of "value signals" –insider trades. Insider trades can be potentially more interesting than guru holdings because of their global nature and information asymmetry. 13F filings are very much unique to the U.S. and international investors don't have the privilege of following their local value investing gurus. Another point is that insiders definitely know more about their companies than any superinvestors do, minus the potential overconfidence bias.
Similar to piggybacking the gurus, there are a few things that value investors can do to improve their odds of bettering their investment performance with the benefit of insider trades.
First, insider buys at small-cap companies are likely to generate more alpha for investors because the problem of information asymmetry is more acute at these smaller companies with less (or no) analyst coverage and media attention. For example, certain value-accretive decisions or plans might go unnoticed at a sub-$100 million market capitalization stock. In contrast, the world's eyes are firmly fixated on Apple (AAPL, Financial), with numerous buy-side investors and sell-side analysts monitoring the company and doing scuttle-butt checks.
Second, it matters who is buying and how much they are buying. It is intuitive that, if many insiders are buying large amounts (relative to their personal wealth or base compensation) of company's stock at the same time, it is a much stronger buy signal. Comparatively, a stock with some insiders buying and others selling sends conflicting signals.
In addition, the seniority of the executive insiders also play a part. I will be excited if both the CEO and CFO of a company buy stock in unison; in contrast, the trades of an independent director, who sits on multiple boards and attends a few company meetings every year, aren't going to get my attention.
The form of purchase also matters. I would prefer if an insider is using his/her cash to buy stocks, rather than exercise stock options awarded.
Third, the insider's past track record is critical as well. If the particular CEO is a mediocre manager who is a perpetual bull, he is likely to have bought heavily into the stock at the peaks. On the other hand, if the CEO in question has a good reputation in the market as a good manager and capital allocator, who has also built his wealth over the years by accumulating the company's stock at the troughs, his trades carry much more weight.
In conclusion, although I do source some of my ideas from gurus and insider trades, I see them as "value signals," the icing on the cake for my original investment theses. While there have been studies and actual funds implementing successful strategies of buying baskets of stocks with strong guru and/or insider buying, I prefer not to tread that path. Instead, the positive signals from superinvestors and CEOs/CFOs are supplementary information that I consider in sizing my ideas that have passed my investment checklists absence the distraction/noise of guru and/or insider buying.
