In this series of research GuruFocus likes to study how investors can take the advantages of companies’ insider trading activities to achieve abnormal returns. A number of screeners and strategies will be developed so that users can generate winning ideas in an easy way.
Long term GuruFocus users may understand that you can generate winning investment ideas with Guru Strategies and Value Strategies we have developed. These strategies were proven to outperform the market over long term.
Are Insiders are also Gurus in term of investing their own companies? If so, how can we take the advantages of it?
There were numerous academic research studies about insider trading activities and their returns. At first we like to summarize some of the conclusions, and answer some questions users may have.
Who are the insiders?
Insiders are corporate executives, board members, or stock holders with 10% ownership in the company.
When do they have to report their trades with SEC?
Insiders are required to report their trades within two business days of they stock trades.
Why follow insiders?
1. Insiders may be better able to evaluate and use the public information.
2. Insiders are mostly value investors: Insiders are found to be net buyers of relatively low P/E stocks and net sellers of relatively high P/E stocks.
3. Insiders tends to be contrarians, that is, they tend to sell more when market buys and buy more when market sells.
A case study shows that after the crash of 1987, insiders were heavy buyers (with 90% being buyers). Oct 20, 1987 had more insider buying than any other day during the study period. Given the insiders’ knowledge of their companies, this buying suggests that collapse was an irrational reaction to the stock price declines over the previous two weeks
4. Insiders tends to be long term investors. The price changes that follow insider transactions occur slowly, suggesting that the insiders are not exploiting upcoming corporate announcements, but are investing on the basis of longer-term prospects for their companies. Abnormal price performance occurs for a full year following the insider trades.
If too many investors follow insider activities, wouldn’t the abnormal returns decline?
Since earlier studies have shown that following insiders is profitable, standard financial theory would suggest that investor would have learned to exploit this information. However, contrary to theory, there is no evidence that profitability of following insiders has declined.
Which are more profitable, insider purchases or insider sales?
Insider purchases are more profitable than sales. This is probably because much selling is done for reasons of diversification or liquidity, while to add to an already large position is often a sign of confidence.
Among all insiders, who are better performers?
Top executives would be expected to be the best informed, and their trades do turn out to be the most profitable. Large shareholders (non-management) are the insiders with the worst performance.
Trades exceeding 10,000 shares provide better signals than smaller trades. Following the insiders in small firms proves more profitable than in large firms.
Do insiders buy more stocks for the firms that are subject to takeovers?
Insiders do not appear to buy more stock in forms subject to takeover attempts than in forms not subject to such attempts.
What is the probability of loss of insider trades?
The probability of a loss from mimicking insiders is surprisingly high. The strategy of mimicking insiders in small firms appears highly profitable. The explanation is that the returns in the stock market are skewed, with winners being more profitable than losers. Thus those mimicking insiders would earn more from their successful transactions than they lose from their unsuccessful ones. This effect appears especially important for the smallest firms.
Do insider activities predict the stock market?
Aggregated insider trading seems to predict market movement, and could be used as a tool to time the market. Insiders seem to be better at timing the market than simple contrarian strategies. When insiders are optimistic, the market do well, and when they are pessimistic, markets do poorly. Insiders do a better job in predicting aggregate movements of small companies than of large companies.
In the subsequent articles we will use the insider trading data from 2004 to current to some of the above conclusions. Study results will be show for the following questions:
In the meantime, you can access GuruFocus insider data:
Long term GuruFocus users may understand that you can generate winning investment ideas with Guru Strategies and Value Strategies we have developed. These strategies were proven to outperform the market over long term.
Are Insiders are also Gurus in term of investing their own companies? If so, how can we take the advantages of it?
There were numerous academic research studies about insider trading activities and their returns. At first we like to summarize some of the conclusions, and answer some questions users may have.
Who are the insiders?
Insiders are corporate executives, board members, or stock holders with 10% ownership in the company.
When do they have to report their trades with SEC?
Insiders are required to report their trades within two business days of they stock trades.
Why follow insiders?
1. Insiders may be better able to evaluate and use the public information.
2. Insiders are mostly value investors: Insiders are found to be net buyers of relatively low P/E stocks and net sellers of relatively high P/E stocks.
3. Insiders tends to be contrarians, that is, they tend to sell more when market buys and buy more when market sells.
A case study shows that after the crash of 1987, insiders were heavy buyers (with 90% being buyers). Oct 20, 1987 had more insider buying than any other day during the study period. Given the insiders’ knowledge of their companies, this buying suggests that collapse was an irrational reaction to the stock price declines over the previous two weeks
4. Insiders tends to be long term investors. The price changes that follow insider transactions occur slowly, suggesting that the insiders are not exploiting upcoming corporate announcements, but are investing on the basis of longer-term prospects for their companies. Abnormal price performance occurs for a full year following the insider trades.
If too many investors follow insider activities, wouldn’t the abnormal returns decline?
Since earlier studies have shown that following insiders is profitable, standard financial theory would suggest that investor would have learned to exploit this information. However, contrary to theory, there is no evidence that profitability of following insiders has declined.
Which are more profitable, insider purchases or insider sales?
Insider purchases are more profitable than sales. This is probably because much selling is done for reasons of diversification or liquidity, while to add to an already large position is often a sign of confidence.
Among all insiders, who are better performers?
Top executives would be expected to be the best informed, and their trades do turn out to be the most profitable. Large shareholders (non-management) are the insiders with the worst performance.
Trades exceeding 10,000 shares provide better signals than smaller trades. Following the insiders in small firms proves more profitable than in large firms.
Do insiders buy more stocks for the firms that are subject to takeovers?
Insiders do not appear to buy more stock in forms subject to takeover attempts than in forms not subject to such attempts.
What is the probability of loss of insider trades?
The probability of a loss from mimicking insiders is surprisingly high. The strategy of mimicking insiders in small firms appears highly profitable. The explanation is that the returns in the stock market are skewed, with winners being more profitable than losers. Thus those mimicking insiders would earn more from their successful transactions than they lose from their unsuccessful ones. This effect appears especially important for the smallest firms.
Do insider activities predict the stock market?
Aggregated insider trading seems to predict market movement, and could be used as a tool to time the market. Insiders seem to be better at timing the market than simple contrarian strategies. When insiders are optimistic, the market do well, and when they are pessimistic, markets do poorly. Insiders do a better job in predicting aggregate movements of small companies than of large companies.
In the subsequent articles we will use the insider trading data from 2004 to current to some of the above conclusions. Study results will be show for the following questions:
- Can insider aggregated activities predict future market movement?
- Do insiders achieve abnormal returns?
- What are the difference in abnormal returns for insiders with different positions (CEO, CFO, directors etc)?
- Are insider clusters buys outperform? Or insider cluster sales underperform?
- Are some insiders smarter than others?
In the meantime, you can access GuruFocus insider data:
