How to Use Insider Transaction Data to Generate Investment Ideas

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Insider transaction data can play a valuable role in investment research. Insiders are some of the most informed participants in the market and a large number of studies have shown that their trading activity can be an excellent predictor of future stock performance.

In this guide, we are going to discuss how insider trading data can add value for investors. Here’s a look at how the analysis of insider buying and selling activity can generate investment ideas and provide insights.

Insider Buying

Insider buying is generally quite easy to interpret. Broadly speaking, insider buying is a bullish signal because it shows that those within the company (i.e. those with the most information on the business) are confident about the future and expect the company’s share price to increase. No insider buys company stock if they believe it’s going to go down. So, if you see insiders buying shares in their own company, it can be worth investigating the stock further.

"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise" – ex-Fidelity fund manager Peter Lynch

It’s worth stressing that some insider purchases are more ‘informative’ than others. By focusing on the most informative trades, you can improve your chances of profiting from insider purchases. We have covered this before but to summarize, the key is to focus on:

  • Buys from top-level insiders such as the CEO, CFO, and Chairman. These kinds of insiders are likely to have the most information on the company.

  • Buys that are large in size. The larger the size of the purchase, the more conviction the insider has in the trade. Size should be measured in relative terms, however (i.e. how much it has increased the insider’s holding by).

  • Cluster buying. This is where multiple insiders are buying stock together. It’s typically a very bullish signal.

  • Large buys in smaller companies. Research has found that insiders at smaller companies tend to earn the largest profits from their trades.

  • Insiders with good track records. Some insiders are more skilled than others when it comes to timing their trades well.

Insider Buying Example: Dell Technologies Inc

In March 2020, when equity markets were falling due to the coronavirus pandemic, Founder, CEO, and Chairman of Dell Technologies Inc, Michael Dell, purchased 828,199 shares in his company when the share price was near $30. In total, he spent around $26 million on stock. Following this insider activity could have been very profitable. Over the next six months, Dell Technologies stock more than doubled on the back of strong demand for work-from-home technology.

Insider Buying Example: Upwork Inc

In May 2020, Upwork board member Greg Gretsch – a founding partner and managing director of a venture capital firm that specializes in marketplace startups – purchased 542,996 Upwork shares when the stock was trading near $10 (and had a market cap of under $2 billion). Then, in August 2020, Gretsch purchased another 547,844 Upwork shares, when the stock was trading near $15. Overall, the insider spent around $13.5 million on the stock. Following this insider activity could have been very profitable. By February 2021, Upwork stock was trading above $50, on the back of the booming gig economy.

Insider Selling

Insider selling is a little more difficult to interpret than insider buying because there are plenty of legitimate reasons that insiders sell stock that have nothing to do with the company’s future prospects.

For example, insiders sometimes sell stock to diversify their investment portfolios. Insiders also sell stock to buy real estate, pay tax liabilities, and pay college tuition fees for their children. Insider selling is still worth monitoring closely, however, as occasionally insiders offload stock because they are expecting the stock to fall. So, it can be helpful in generating short-selling ideas.

When analyzing insider selling, there are a few red flags to look out for. One is large sales from multiple insiders. This selling pattern is generally a bearish signal. Another is one or more insiders selling all of their stock. This is also generally a bearish signal.

It’s important, however, to distinguish between regular insider sales and automated / pre-planned sales when analyzing insider selling activity. Pre-planned sales, such as those arranged through Rule 10b5-1 trading plans, generally have less informational value than regular sales.

Insider Selling Example: Virgin Galactic Holdings Inc

On 3 March 2021, Virgin Galactic’s Chairman Chamath Palihapitiya – who took the company public through a SPAC deal in 2019 – sold 6.2 million SPCE shares when the stock was trading around $33 to $35 level. This sale generated proceeds of approximately $213 million for the insider. Following this insider selling activity could have been very profitable on the short side. By mid-May 2021, the stock was trading at $15.

Insider Selling Example: Plug Power Inc

On 19 January, President and CEO of Plug Power Andrew Marsh sold 573,268 shares at a price of $65.82 per share. This sale – which was worth $38 million – was prearranged. However, it reduced the size of his holding by 43% – a significant amount. Following this insider selling activity could have been very profitable on the short side. By mid-May 2021, the stock was trading under $20.

Aggregate Insider Buying and Selling

Insider transaction data can also be used to predict shifts in both the broader market and specific sectors.

In the late 1980s, insider transaction expert Nejat Seyhun examined the relationship between market movements and aggregate insider trading in a paper entitled ‘The Information Content of Aggregate Insider Trading’ (The Journal of Business, 61.1, 1988, 1-24). His goal was to determine whether publicly available information about aggregate insider trading activity can help predict future stock-market returns and provide investors with market timing ability. The study involved the analysis of 60,000 open-market purchases and sales by insiders from January 1975 to October 1981.

Interestingly, Seyhun found that the net aggregate insider activity in a given month is significantly positively correlated with the return to the market portfolio during the subsequent two months. His research showed that, in the aggregate, insiders increased their stock purchases prior to increases in the stock market and decreased their stock purchases following increases in the market. In other words, his research found that insiders are pretty good at timing the market.

Seyhun’s research is in line with our own findings on aggregate insider trading. We have found that insiders tend to buy company stock during periods of market weakness and tend to hold back from buying when stocks, as a whole, are expensive. For example, in March 2020, when global equity markets were in meltdown mode due to Covid-19 fears, insiders bought company stock in record numbers. Soon after, global equity markets rebounded, meaning many insiders generated large profits.

We have also observed similar patterns in specific sectors. When sectors are out of favor with investors, insiders are often buying. For example, in late 2020, we observed heavy buying from insiders in the financial sector, which was out of favor at the time. In the first quarter of 2021, this sector was one of the best performing areas of the market. By taking note of the huge amount of buying in this area of the market, and following insiders into the sector, investors could have generated significant profits.

The Best Way to Use Insider Transaction Data

Overall, there are a number of ways to use insider transaction data to generate investment ideas. The data can be used to identify individual stocks to buy or sell, to identify sectors that could outperform, and to determine whether the overall market is undervalued or overvalued. It can be used by both value and growth investors, as well as both fundamental and quantitative investors.

The best way to use insider trading data is to combine it with other forms of investment analysis. When used in conjunction with other data, insider transaction data can add significant value and help generate outperformance.

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