It’s widely considered that insider purchases –Â managers buying stock in their own companies –Â are strong bullish signals. Insiders have an unparalleled view of the company’s current trading and fortunes, so they are in the best position to profit from a well-timed and legal trade.
There is plenty of data that supports this conclusion. One of the most comprehensive studies on the subject was published in 1998.
Insider buying indicates outperformance
According to Catalyst (research by H. Nejat Seyhun published in Investment Intelligence from Insider Trading, The MIT Press, 1998), between 1975 and 1994 following insider buying stocks outperformed the market by 4.5% while following insider selling stocks underperformed the market by 2.7%. These results are based on an exhaustive data set, capturing information on insider trading from around 1 million transactions in publicly traded firms over two decades.
This isn’t the only study that has been conducted on insider transactions, but it is the largest and most comprehensive. Other studies show similar results; although the study period is a lot shorter in most cases, they all reach the same conclusion.
One such study was published in Fortune magazine by the legendary Carol Loomis in April 1985. Fortune screened the 1,660 stocks in the Value Line Investment Survey and selected all companies that had purchased significant amounts of their own shares in the 10-year period from 1974 through 1983. The total investment return for the stocks with the highest level of insider buying during this period was a 22.6% average compounded rate of return while the Standard & Poor's 500 only returned 14.1%.
The following studies on the same topic of insider buying are highlighted in Tweedy Browne’s research document What Has Worked In Investing, Studies of Investment Approaches and Characteristics Associated With Exceptional Returns.
- Donald T. Rogoff, “The Forecasting Properties of Insider Transactions,” Diss., Michigan State University, 1964.
- Gary S. Glass, “Extensive Insider Accumulation as an Indicator of Near Term Stock Price Performance,” Diss., Ohio State University, 1966.
- Charles W. Devere Jr., “Relationship Between Insider Trading and Future Performance of NYSE Common Stocks 1960-1965,” Diss., Portland State College, 1968.
- Jeffrey F.Jaffe, “Special Information and Insider Trading,” Journal of Business, July 1974.
- Martin E. Zweig, “Canny Insiders: Their Transactions Give a Clue to Market Performance,” Barron’s, July 21, 1976.
The results of each study are shown in the table below:
Nejat Seyhun concludes in his study that on the whole, insiders do earn profits from their legal trading activities (a statement that is supported further by the evidence above), and their returns are greater than those of the overall market. However, investors should not necessarily follow insider deals without doing their own research. Investopedia’s description of insider dealing sums up the argument.
“Surges in insider trading appear to divine an upcoming switch in the market’s direction. But outside investors have to be awfully careful about reading positive messages into every insider buy they see. Investors must also avoid treating individual sales as signals to unload their own holdings.”
Also:
“Research supports the view that insider information works best in the aggregate. Independent research firm Market Profile Theorem (MPT) showed that insider trading trends signal an up-and-coming shift in market sentiment.”
The Claymore/Sabrient Insider ETF, which tracks the Sabrient Insider Sentiment Index — an index of 100 stocks and ADRs with favorable insider buying trends — was created to capitalize on insider trading activity.
The performance of this ETF over the past decade confirms what the studies above appear to show. Indeed, during the last decade, the ETF has returned 127% while the S&P 500 has returned 56.8% and the Dow Jones Industrial Average is up by 50.9%. Over the past five years, the Insider ETF has gained 96.7% compared to the S&P 500’s return of 86.9% and the Dow Jones return of 64.2%. Over the past year, the ETF is up by 16.1% outperforming both the Dow Jones and S&P 500 by 2.5% and 1.5%. All these figures exclude dividends.
There’s no doubt that following insider buying trends can produce outperformance, but insider buying should never be used as a stand-alone indicator and should always be combined with other analysis to produce the best results.
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