In today’s Exponential Investor

  • Can this get you ahead of the market?
  • Why insiders are better investors
  • How to benefit from their advantage

There’s a grey area between investing normally like we do, and insider trading.

We have no non-public information. Insider “trading” involves the illegal use of non-public information to profit from the news ahead of the market.

Trading alongside an insider, not insider trading

But what if I told you that there was a group of people with greater access to information, who trade regularly, and historically tend to do better than most investors? And that you can follow their every move, and benefit from their insights?

This, ladies and gentlemen, is the study of insiders buying, and selling. Completely legal, transparent, and a well-established part of the SEC’s oversight of corporate management teams.

These “insiders” are not criminals, they are just the management teams of companies. CEOs, CFOs, COOs and the rest. You can imagine that they’ve got a pretty good idea of how their companies are doing…

How do they beat the market?

These executives and directors have the most up-to-date information on their companies’ prospects.

They have two advantages. Firstly, they have the most up-to-date information on order flow, supply and production bottlenecks, costs, and how the competition are doing.

They are also industry experts, whose expertise and understanding gives them a better picture of whether the industry as a whole has good prospects or not.

These insiders are way ahead of analysts and portfolio managers, not to mention individual investors.

But there is good news for us outsiders

Since the Sarbanes-Oxley Act (legislation enacted in the United States a in the early 2000s) corporate executives and directors have had to notify the regulator of any purchases or sales of shares in their own companies, usually within two days.

That means that going back 20 years at least, we have comprehensive data on how their purchases and sales stack up against the rest of us.

And what has been found is that there is a clear advantage to the enhanced position these people have in terms of trading in their own companies’ shares.

They also demonstrate particular characteristics. They have a better grasp of value and longer time horizons, which allows them to buy dips, and helps them to sell when market investors get carried away buying their stock.

You can see this here, where insider buying clearly spikes as the market dips. It’s also interesting to note that insider buying is at its lowest in years right now, relative to selling, suggesting that insiders are as uncomfortable with the current high valuations as I am.

This pattern is in keeping with long-term behaviour of insiders’ investment decisions.

Insiders have demonstrably invested in a contrarian fashion during crashes and bubbles.

Another reason for this might be that they are more insulated from the collective madness of crowds that can infect market investors in some periods.

Consider this quote from Sun Microsystems CEO Scott McNealy, for example:

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

While investors were getting carried away imagining the incredible wealth tech and internet companies could deliver in the decades to come, as CEO he was acutely aware that what mattered was cash flow, costs and profits.

(For what it’s worth, because of this quote, 10x price-to-sales (PS) ratios have become somewhat of a marker post. A sign of hysteria, so to speak. Well today, the market capitalisation of stocks with a PS ratio over 10x is more than twice as high as back in 2000, when McNealy gave his views on investing in companies with such crazy valuations.)

How do we benefit from their advantage?

Overall, insiders seem to have calmer heads, and be more attuned to value and real time company performance, with the benefits of industry expertise and real time data.

That’s why investors have been searching for a way to follow the signals given off by insider buying and selling.

That’s why we are launching a brilliant new service, spearheaded by market veteran Brian Christopher.

Brian has a three-pronged approach with an emphasis on value and quality, using publicly disclosed insider transactions as a signal according to his own rigorous method.

If this sounds like the kind of thing you might be interested in…

Then click here to find out more.

All the best,

Kit Winder
Co-editor, Exponential Investor