What Is It and Why Is It Powerful?
When analyzing insider transaction activity, there are several 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. However, perhaps the most bullish insider buying indicator is what’s known as ‘cluster buying’.
Cluster Buying Is Defined As:
A stock purchasing event whereby three or more top-ranking company insiders make open market purchases within quick succession of one another.
This guide looks at why cluster buying is such a powerful insider transaction indicator, and explains how investors can use cluster buying patterns to generate profitable investment ideas.
What Is Cluster Buying?
The definition above is only a small glance at what cluster buying is. When we look a bit deeper under the surface, we see that cluster buying is when company insiders at the C-suite, chairman or stockholder levels of a company buy stock in tandem of one another in a relatively short period of time.
So, for example, if a company’s CEO, CFO, COO, and Chairman all buy company stock within two days of one another, 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 Signal?
Investors are always looking for signs that could indicate what the market could be doing to make future buying decisions. Cluster buying is but one of the indicators investors can look out for, though it is a particularly strong insider transaction signal. Cluster buying indicates a strong positive sentiment among decision-making, high level insiders. If only one insider is buying stock, it could be for any number of reasons. A single purchaser isn’t a guaranteed indicator that the outlook for the stock is favorable. They may simply be an optimist or want to invest in their company for other reasons.
Alternatively, if a group of three or more insiders all buy stock at the same time, we have a powerful consensus. This pattern of buying signals informed decision-making among top-level insiders and can be a strong indication that the stock is undervalued and could increase in the coming months.
Do Insiders Outperform the Market?
According to a study done by the Journal of Business and Economic Policy in September 2017, which analyzed the trading activities of insiders from January to December 2013, they in fact do.
Their research indicated that:
- Insiders beat the market 24.94% over a one-month period
- 30.59% over a six-month period; and
- 36.33% over a one-year period.
What Else Does Academic Research Say About Cluster Buying?
Several studies on insider transaction activity have surmised that investors can confidently conclude that cluster buying is a powerful insider signal that there will be positive movement from a specific stock.
A 2017 study by Dallin Allredge and Brian Blank entitled ‘Do insiders cluster trades with colleagues? Evidence from daily insider trading’, is but one example from many. This study examined US open market transaction data (sales and purchases) from January 1986 to December 2014 and 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.
Another study in 2018 by Chang-Mo Kang, Donghyum Kim and Qinghai Wang entitled ‘Cluster Trading of Corporate Insiders’, also supports the theory that cluster buying by top insiders is a solid foundation for investor research. This study analyzed US corporate insider trading dates from 1986 – 2016 and found:
- 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, research indicates cluster buys are more informative than solitary insider buys. It hypothesises that cluster buying exhibits stronger return predictability than insider purchases not made in clusters.
How Can Investors Use Cluster Buying to Their Advantage?
Given that studies show that cluster buying provides significant insight into the potential future of a stock, investors can further research these 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 and with additional research could be cause for action.
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 happen time and again, and there are several instances of it each year. It only matters that you know where to look and what to look for.
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.
A more recent example is the cluster buys around Yellow Corp (YELL:US), a United States-based logistics firm. Insider cluster buys of this stock were relatively unheard of until December 2021, when:
- Director Matthew Doheny purchased 56,000 shares
- Director David McClimon purchased 20,000 shares; and
- Director Douglas Carty purchased 10,000 shares.
The YELL stock purchases amounted to nearly $1.1 million spend between the three Directors, and is a sign that they are optimistic that the stock price will continue to rise.
December 2021 was a big month for cluster buys, with an additional cluster happening around Blucora Inc (BCOR:US). A tax-focused management company, Blucora experienced significant insider trading activity, including:
- President & CEO Chris Walters purchased 10,000 shares
- CFO Marc Mehlman purchased 10,000 shares
- Chair Georganne Proctor purchased 3,025 shares; and
- Board Member Mark Ernst purchased 50,000 shares.
This cluster buying pattern was significant for a couple of reasons. First, three senior insiders purchased stock and would have internal knowledge of the company’s prospects and future.
Second was the purchase made by Board Member Mark Ernst. While not a senior member of staff, Ernst is an investment specialist with a history of holding senior company positions including Chairman, President and CEO. With his vast knowledge of the investment space, it would definitely have been worth watching for further insight.
How To Find Cluster Buys
There are two 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, this method is exceptionally time-consuming.
The other and much easier way to find cluster buys is to subscribe to an insider transaction data provider, such as 2iQ Research. Through a service such as this, you can watch the market for cluster buys. 2iQ Research’s insider transaction software allows users to set up alerts notifying them when specific stocks, such as those in their portfolio or watch list, have cluster buying activity. This is a much more manageable way to identify cluster buying in the world’s publicly listed companies.
We’ve defined cluster buying as an event where multiple insiders are buying stock within a short period of time. Noting that it’s one of the strongest signals in insider buying.
We’ve also outlined research that shows cluster buying is more informative than solitary insider share purchases 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.