Insider stock trading is just one small measure among many for finding the best investments

The value of insider stock trading as a market indicator seems self-evident. After all, company insiders —officers, directors, or owners of 10% or more of a company’s stock—are apt to know more than outsiders about what’s going on in their business.

Some investors claim that they can find the best investments by studying insider stock trading data. But the deeper you look, the more you’ll find that this data leads to muddled conclusions at best. That’s why insider trading is only one small aspect we consider when we’re looking for the best investments to recommend in our newsletters and investment services.

Not all insider stock traders have equal knowledge. It would help if you could categorize the clout that each insider has within the organization. You’d expect the CEO to have a better overall picture of things than the CIO (the chief information officer, who keeps the corporate computers running). You’d also want to grade the size of the transaction in relation to the insider’s personal wealth, and in relation to his or her stake in the company. You would also want to weigh the insider’s investing skills.

Of course, if you look at insider stock trading that closely, you’re down to a case-by-case basis. While you’re at it, you might as well look at whatever else you can find out about the company.

That’s what we would recommend in any event. But that of course defeats the labour-saving purpose of using an indicator to find the best investments.

Insiders’ perception can be just as skewed as outsiders’. It pays to remember that insiders can delude themselves about their employer just as easily as outsiders. As well, insiders may sell for a variety of personal reasons that have nothing to do with the company. On the other hand, insiders only make substantial buys for one reason—they think the company has attractive investment appeal.

Everybody wants to find the financial philosopher’s stone: the foolproof market indicator that can tell you when or what to buy or sell in 10 minutes a day or less. However, they will never succeed, because no such indicator can ever exist.

By design, market indicators restrict the information they include to a narrow range, and reject everything else. The market responds to virtually anything that can influence the business of a company or the economy, though its focus constantly shifts.

If you stick to high-quality stock picks, however, your short-term gains and losses can average out and you’ll still profit greatly in the long run. Here are nine factors to look for when judging a value stock pick’s investment quality—including insider stock trading.

Financial factors:

1. 5 to 10 year history of profit. Companies that make money regularly are safer than chronic or even occasional money losers.
2. 5 to 10 years of dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.
3. Manageable debt. When bad times hit, debt-heavy companies go broke first.

Safety factors:

1. Industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves. Minor firms, on the other hand, don’t have that power.
2. Geographic diversification. Canada-wide is good, multinational better. There’s extra risk in firms confined to one geographical area.
3. Freedom to serve (all) shareholders. High-quality value stock picks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.

Survival/growth factors:

1. Freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. That’s why you need to diversify. Invest in utility, finance and consumer stocks, along with resources and manufacturers.
2. Ability to profit from secular trends: These trends outlast ordinary business booms and busts, because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.
3. Ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will try their new products.
4. Insider stock trading. Seeing company management buying up shares can indicate a sign of trust or growth in a company.

Finding a stock with all of these indicators is next to impossible, so try to find the ones that have the most.

Insider stock trading is one indicator you can use when researching value stocks. Have you used insider stock trading information to make a buying decision? Share your experience with us in the comments.