Stock Market for Beginners

“Insiders might sell their shares for many reasons, but they buy for only one: they think the price will rise”
- Peter Lynch

In Part 1 of this series, I gave a broad overview of insider buying and how it can benefit your investment portfolio. In this article, I’ll discuss concrete insider buying strategies.

With so many sources online now that provide insider buying data and so many daily filings of individual buys, it can be overwhelming trying to decide which information is the best indicator for future price appreciation. As I have demonstrated, not all insider buys are relevant, but from my experience, filings from insiders that actually run the company have been the best indicators. Filings from CEOs, CFOs, COOs, Vice Presidents and other operations personnel have been the most informative because these individuals are usually aware of their stock price but are not traders trying to cost average or time technical trends.

These individuals are busy with the daily operations and usually invest their hard earned money only when things are looking up or some positive news may be forthcoming. Within this group, filings of buys from the CFOs, and COOs are more significant than buys from the CEOs because CFOs and COOs have more direct access to the details of the company while CEOs are usually the salesmen and visionaries involved with the overall direction of the company. Also, CFOs and COOs make less money than CEOs so a financial commitment to the company stock is much more telling.

These financial commitments that insiders make to their stock must be substantial to be considered good indicators of future price appreciation. Insiders usually earn six figure salaries, so a $2,000 commitment does not show overwhelming confidence in the share price. Also, do not be fooled by the number of shares an insider purchases because insiders can buy a large amount of shares with very little money when dealing with stock less than $5. Focus on the total dollars committed and how large it is in relation to the insider’s connection to the company. Hedge funds, beneficiary owners, board members, and CEOs have deep pockets, while officers and operations people usually make much less.

After considering the dollar amounts, try to see if there is an overall trend to the insider buying. It is usually a good sign when more than one insider is buying and the dollar amounts for each is high. It is also a good sign that these individuals have been buying consistently in the past with the absence of insider selling. Even though insider selling is not that strong of an indicator for stock declines, when there are more insiders selling than buying, I would consider it a bit bearish.

Next, look for a good track record. When an insider buy looks interesting, research the individual doing the buying to see if his past buys have been successful. It is often uncanny how successful certain individuals have been while others in the same position have been completely wrong. When it becomes evident that an individual makes good insider trades, just follow along. This strategy is similar to buying stocks that Warren Buffet buys. Further research on these types of individuals will usually show that they have other holdings that might have potential.

Because the market is becoming more efficient about insider buying transactions and their potential, be careful about trying to buy a stock that has already appreciated too much. For example, an insider with a good track record just bought some stock at $20 a share two days ago and the stock is trading $23 today. Speculators may have jumped in causing the $3 appreciation. This stock may not be a good buy now because the potential good news is already priced into the share price. Trying to buy shares close to the price an insider bought at is important because the insider was confident at that price level and the potential good news has not been priced into the stock yet.

These are the main strategies investors should apply when using insider information to make investment decisions. Being a good investor takes a lot of patience, research and experience. These same traits are needed to decipher the vast amount of insider buying data that is reported everyday. Mastering this skill will provide great rewards. Just ask Peter Lynch, Jim Cramer, and all the money managers and analyst out there using insider information to be successful.

<< Insider Buying (Part 1): Overview <<

>> Insider Buying (Part 3): More Tips >>

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