What is cluster buying and why is it such a powerful insider signal?

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When analyzing insider transaction activity, there are a number of things to look for. A buy from a top-level insider such as a CEO or CFO is a good sign. So is a large purchase that substantially increases the size of an insider's holding. Perhaps the most bullish insider buying indicator, however, is what’s known as ‘cluster buying.’ This is where multiple insiders are buying stock within a short period of time.

In this guide, we look at why cluster buying is such a powerful insider transaction indicator. We also explain how investors can use cluster buying patterns to generate profitable investment ideas.

What is cluster buying?

Cluster buying can be defined as a series of open-market purchases by three or more insiders in the same stock within a short period of time. So, for example, if a company’s CEO, CFO, COO, and Chairman all buy company stock within the space of two days, that’s a cluster buying pattern. All the same directional trades placed within the short space of time represent a unique trading cluster.

Why is cluster buying a powerful insider transaction signal?

Cluster buying is a particularly strong insider transaction signal because it’s a sign of consensus of insider opinion. If just one insider is buying stock, we can’t be sure that the outlook for the stock is favorable. He or she may simply be an optimist. Yet if four or five insiders are all buying stock at the same time, we have a powerful consensus. This pattern of buying can be a strong indication that the stock is undervalued.

What does academic research say about cluster buying?

A number of studies on insider transaction activity have concluded that cluster buying is a powerful insider signal.

A 2017 study by Dallin Alldredge and Brian Blank entitled ‘Do Insiders Cluster Trades with Colleagues? Evidence from daily insider trading’, is one example. This study, which examined US open market sale and purchase transaction data from January 1986 to December 2014, found that:

  • Clustering is greater when informational advantages are larger.
  • Clusters tend to take place during periods of high information asymmetry (information asymmetry was measured using subsequent earnings surprises).
  • Insider purchases are more profitable when corporate insiders cluster their trades.
  • Insider purchases that occurred within two days of a peer insider purchase generated abnormal returns of 2.1% over the next month – 0.9% higher than the abnormal returns following solitary insider purchases.

The 2018 study by Chang-Mo Kang, Donghyun Kim, Qinghai Wang entitled ‘Cluster Trading of Corporate Insiders’, is another example. This study, which analyzed US corporate insider trading data from 1986 to 2016 found that:

  • Cluster buys of top executives, not just with other top executives but with other executives and directors, are more informative than individual insider purchases.
  • Cluster buys have larger price impacts and lead to stronger market reaction at their disclosures than non-cluster purchases. Cluster purchases essentially accelerate post-trade stock price adjustments.
  • Over holding periods of 21 trading days, the abnormal returns earned by cluster purchases were almost twice as high as those of non-cluster purchases (3.8% vs. 2%). The return gap was even wider over longer horizons, reaching 2.5% over a 90-day horizon.

Overall, the research shows that cluster buys are more informative than non-cluster insider buys. It also shows that cluster buying exhibits stronger return predictability than non-cluster insider purchases.

How can investors use cluster buying to their advantage?

Given that studies have shown that cluster buying is more informative than non-cluster buys, investors can potentially use cluster buying patterns to generate investment ideas. If multiple insiders are buying stock within a short space of time, it could be interpreted as a bullish signal.

Of course, cluster buying is not a guarantee that a stock will rise in the future. Insiders tend to outperform the market, yet they don’t always get their timing right. However, if multiple insiders are buying stock within a short space of time, the stock is probably worth further research.

Cluster buying examples

Examples of cluster buying before a significant increase in a company’s share price are not hard to find.

A good example is a series of purchases at UK consumer goods company Reckitt Benckiser (RB:LN) in March 2020. Between 2 March and 11 March – a period in which equity markets were falling sharply due to Covid-19 – four top-level insiders at Reckitt Benckiser purchased stock including:

  • CEO Laxman Narasimhan (17,241 shares)
  • CFO Jeff Carr (20,000 shares)
  • COO Hygiene Harold Van den Broek (8,000 shares)
  • COO Health Aditya Sehgal (10,000) shares

Combined, these insiders spent approximately £3.2 million on Reckitt Benckiser stock in the space of just over a week.

Over the next four months, Reckitt Benckiser stock rose approximately 37% on the back of strong quarterly results. In comparison, the FTSE 100 index rose just 4% over the same period.

Another good example is a series of purchases at Element Fleet Management (EFN:CN). In early 2018, Element Fleet Management shares experienced a period of weakness after the group announced that CEO Bradley Nullmeyer was stepping down and that going forward, it would be continuing to execute its current strategy. Between 16 May and 23 May, eight different insiders purchased stock including:

  • Acting CEO Daniel Jauernig (108,000 shares)
  • Soon-to-be CEO Jay Forbes (200,000 shares)
  • Ex-Chairman William Lovatt (100,000 shares)

Over the next 12 months, Element Fleet Management stock rose nearly 75%. In comparison, the S&P/TSX Composite index rose just 1%.

How to find cluster buys

There are two main ways investors can find cluster buying patterns. The first is to simply examine individual insider transactions. You can find insider transactions on public databases such as the US SEC’s Edgar database. This approach is straightforward, however, it’s also very time consuming.

The other way is to subscribe to an insider transaction data provider such as 2iQ Research. Through this kind of service, you can screen the market for cluster buys and set up alerts to notify you when specific stocks, such as those in your portfolio or watch list, see cluster buying activity. This is a much easier way to identify cluster buying in the world’s publicly-listed companies.

Summary

Cluster buying is where multiple insiders are buying stock within a short period of time. It’s one of the strongest signals in insider buying. 

Research shows that cluster buying is more informative than non-cluster buying and tends to take place during periods of high information asymmetry. Due to its informative nature, cluster buying can be used by investors to generate trade ideas.

Focusing on this pattern of buying can reduce the risk of misinterpreting ad-hoc buying by insiders that may actually mean very little.

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