Insider stock trading hints at companies' prospects

Purchases more reliable than sales, analysts say

Dollars & Sense


At Enron Corp., the jackpots came easily and quickly: Since 1998, company executives and directors sold stock worth $1 billion.

In hindsight, the enormous sales of Enron stock by Chief Executive Officer Kenneth L. Lay and other insiders should have raised a red flag, brightly painted with the word "sell," for investors wondering about the company's future.

If only it were so easy. But while insider transactions rarely shout "buy" or "sell," they do often hint at a company's prospects.

"Usually, it's a good sign if executives are buying and a bad sign if they're selling," said H. Nejat Seyhun, professor of finance at the University of Michigan. "But you can't place sure bets. ... I would look at it as a signal among other signals."

Most of the time, insider purchases are a stronger signal than sales. That's because executives and directors have a host of reasons for selling - to make a charitable gift, to diversify investments or to pay for a child's college education. Insiders have few incentives to buy unless they believe the stock is going places.

Long-term studies have shown that insider purchases, especially at companies whose stock price is cheap relative to the overall market, generate outsized returns, said John D. Spears, co-manager of Tweedy, Browne American Value Fund and Tweedy, Browne Global Value Fund.

When he picks stocks for his funds, he seeks out companies whose shares are inexpensive relative to earnings or book value. News about insider purchases often tips the balance in favor of buying.

Context is the key to judging insider sales and purchases. Jeff Auxier, manager of the Auxier Focus Fund, sold Enron shares in part because he didn't like the pattern of insider selling. The sales bothered him especially after executives grew increasingly defensive when asked about earnings.

Lon Gerber, director of insider research for Thomson Financial, advises investors to consider whether an executive's or director's decision to sell deviates from a normal pattern of selling. If so, it may signal a problem. Similarly, executives and directors selling as a group may hint at trouble.

Group buying, on the other hand, suggests confidence in a company's future. Auxier said insiders tend to be good judges of what their companies are worth, so they buy when they think the stock is undervalued.

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