Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on how you to find the best investments for your portfolio. Each Investor Toolkit update gives you a fundamental piece of investment strategy, and shows you how you can put it into practice right away.
Tip of the week: “While insider trading can sometimes be a useful indicator for investors, there are also occasions when it can be misleading.”
The value of insider buying and selling as a market indicator seems obvious. Company insiders—officers, directors, or owners of 10% or more of a company’s stock—are bound to know more than outsiders do about what’s going on in their business.
Many advisors claim that studying insider data can lead them directly to the best investments. But the deeper you look, the more you’ll find that this data often leads to ambiguous conclusions. That’s why insider trading is only one aspect we consider when we identify the best stocks to recommend in our newsletters and investment services.
Here are two reasons why insider trading is not always a reliable guide:
Not all insiders have equal knowledge. It would help if you could calculate the influence 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 trading data 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 it defeats the labour-saving purpose of using one indicator to uncover promising stocks.
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The inside view may be no clearer than the outsider’s perspective
Insiders’ perception may be no more discerning than that of outsiders. It pays to remember that insiders can be mistaken about their company’s prospects 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.
Our investment advice: Many people would like to find the financial philosopher’s stone: the foolproof market indicator that can tell you when or what to buy or sell in one simple formula. But 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. Put in that perspective, insider trading is just one of many factors.
That’s why we say investment success flows from mainly investing in well-established companies and spreading your money out across the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).
This may reduce the excitement, but it will increase your long-term returns.
COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members
Do you have any particular sign or indicator you rely on more than others when you are deciding on a stock? Why do you find that indicator more helpful than others? Has it ever misled you?
Note: This article was previously published on July 11, 2012.
Comments
Ronald
Dear Pat;
Thanks for the “heads up” on insider trading. I agree. But as Kevin O’Leary says: “It’s the money that counts”.
I say, if the company doesn’t pay a decent, consistent dividend that has been growing over the past several years, be very, very careful. O’Leary won’t even buy non-dividend paying stocks. Enough said!
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Dear Pat;
Thanks for the “heads up” on insider trading. I agree. But as Kevin O’Leary says: “It’s the money that counts”.
I say, if the company doesn’t pay a decent, consistent dividend that has been growing over the past several years, be very, very careful. O’Leary won’t even buy non-dividend paying stocks. Enough said!
Ronald E. Baker