Want an indicator that will tell you when a company’s fortunes are about to take a turn for the better? Christopher Browne, the author of “The Little Book of Value Investing,” recommended watching the buying and selling activity of senior management and directors: the insiders.
They are the best positioned to know what is happening in a company, so when they begin buying in the open market, the rest of us might rightfully believe good things are just ahead.
Since all transactions by insiders must be reported quickly, it is not hard to track what they do. In addition, Browne wrote, “Any time an insider buys or sells stock, it is public information within 48 hours. This allows us to invest our money very close to the same time that the people running the company decide to invest theirs.”
Now, the author argued that when an insider buys, it is a good indicator. But he did not say the opposite would also apply, that when an insider sells it means bad news is coming. That’s because management or members of a board have many reasons to sell their shares. For example, insiders in a company will likely sell some of the stock they received for hitting their operational targets. By selling, they can diversify their holdings.
Some sell their stock because they’re getting divorced and need a lump sum to settle with their spouses. Others may sell because they are doing estate planning or because they’ve decided to buy a dream house. Sellers sell for many reasons.
Buyers buy for only one reason (usually)—they expect the stock price to increase. Perhaps the stock is undervalued, and they expect it to revert to the mean, or perhaps they see a new marketing program is working well. If insiders begin buying, it’s worth investigating further.
According to Browne, research supports this conclusion, with one or more studies finding that stocks purchased by insiders beat the market by a margin of at least two-to-one. This holds in other countries as well, at least in those where insiders must report their buying and selling.
Another facet of insider buying worth mentioning: When insiders are buying stocks available at low multiples of earnings or below their asset value, that’s even better. Add to that the observation that consistent purchases are a better indicator than one-time purchases, when available below book value.
Insiders also may signal improved expectations by buying back stock, or buying stock using the company’s money rather than their own. Share repurchases reduce the number of shares outstanding, thus increasing the value of stocks that remain.
Of course, there’s an important caveat that goes with that: Buybacks should occur when shares are selling for less than their book value. Browne added, “With so many potential benefits from a share buyback, it makes sense to look closely at companies announcing stock buybacks that appear to be cheap relative to earnings or assets.”
For value investors, there is a good reason to follow the lead of insiders. They are usually buying for the long term, meaning they are investors, not traders. They see long-term value in their companies as “insider purchases are often a signal to the kinds of companies we seek for the shelves of our value investing store because they often have the other traits that make them strong candidates.”
An interesting variation on that idea is when insiders buy and accumulate at least 5% of a company. Once an individual or entity secures that 5%, they must report to the Securities and Exchange Commission. Part of that reporting refers to their intentions: They are required to state whether they bought the stock as an investment or to lobby for change or seek control of the company. Browne wrote, “Many of these larger investors have successful track records, and it’s worth noticing if they have a large position in a stock that appears undervalued. Knowing that very successful investors are interested is a reason for us also to take a look.”
Browne added that while not all activists are successful, knowing they are watching “offers one more screen for value opportunities.” Often, management will make extra efforts to improve shareholder returns when activists arrive. Failure to increase shareholder value could mean senior executives lose their jobs in an activist shakeup. Again, this will be especially significant if the stock is selling at a low multiple of earnings or assets.
In concluding the chapter, the author wrote, “Sometimes the only thing standing in the way of a cheap stock and a profit for an investor is a catalyst that can make the market take notice. Both insider buying and activist investors can provide the push that makes the market realize a stock is a good value.”
Read more here:
- Christopher Browne: Foreign Investments and Treasure Hunts
- Christopher Browne: Low Book Value Deals & Foreign Bargains
- Christopher Browne: In Praise of Low-PE, Low-Expectation Stocks
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- 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.
