Insider Buying and Selling
In today’s investment landscape, retail investors often find themselves competing against quant-based analysis, which pours hundreds of millions of dollars into similar strategies. Unfortunately, this leaves little room for the average investor to gain an edge. However, thanks to regulatory frameworks, there are certain insights available to retail investors, one of which is insider buying. While the exact timing of these trades may be obscured by grey areas in reporting, the key takeaway is that insider buying serves as a valuable heads-up that insiders are confident in their company’s future.
Why is this significant? As the legendary investor Peter Lynch once said:
“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” —Peter Lynch
Insider buying carries more weight than selling, as there are myriad reasons for selling that often have nothing to do with the company’s performance—divorce being a prime example. When insiders buy shares, they are increasing their exposure to the stock, which is a strong indicator of their confidence in the company’s prospects. In essence, insider buying is akin to doubling down on a significant investment.
Peter Lynch advocated for investing in companies you understand. He shared an anecdote about a fireman in the 1950s who, noticing a local company (Tambrands) expanding, bought shares without fully understanding their business. By 1970, he retired a millionaire. Similarly, I invested in NVIDIA for my mother’s portfolio in April 2016, driven by my company’s pitch for their business, which revealed a compelling strategy for AI. However, Lynch also cautioned:
“Finding the promising company is only the first step. The next step is doing the research.”—Peter Lynch
NVDA Case
The NVIDIA investment was based on a diversified portfolio and an understanding of semiconductor stocks. A compelling RFP was just one factor in my decision. Insider buying should always be approached with a comprehensive strategy. A recent Reddit post highlighted that not all insider buying leads to success.
Figure 1 Source r/options on Reddit 02/25/2024
The research covered a three-year period and serves as a sobering reminder that blindly following insiders isn’t always fruitful. While the analysis aimed to promote insiderxtrade.com, it provided valuable insights. The findings suggested that smaller-cap stocks may only be interesting in the short term, while mid and large-cap stocks may offer more reliable insider insights. Interestingly, while insider buyers had larger wins than the S&P, simply trading the index yielded more consistent positive returns.
Whom Should You Follow?
This leads us to an important question: which insiders should we follow?
The answer lies in identifying insiders whose actions align with other indicators suggesting a stock’s potential. Warren Buffet’s adage that last year’s winners may not repeat can be a trap for investors. A reasoned approach to insider buying can be illustrated through two defense sector companies: RED is Lockheed Martin (LMT), and BLUE is Rheinmetall (RHM.DE).
To interpret the chart below, note that both companies are subject to quarterly trading windows, making insider purchases easily identifiable.
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Points 1 & 2 in yellow highlight significant public events—Russia’s invasion of Ukraine and Germany’s €100 billion defense spending announcement. While both events impacted defense stocks, only the latter significantly boosted Rheinmetall. US defense firms may be more profitable, but European companies like Rheinmetall are poised for faster growth from a lower base.
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The white dots represent insider buying in LMT, primarily from John Donovan, who has not had the best luck with his investments. Despite being one of 115,000 employees, he stands out as the only insider buyer among numerous trades.
- In contrast, Rheinmetall’s reddish-pink numbers indicate multiple insider purchases, with only two sales from a single individual. This stark difference highlights the enthusiasm among Rheinmetall insiders compared to LMT.
The performance gap is significant, with Rheinmetall outperforming LMT. However, not all purchases were perfectly timed. The stock’s meteoric rise in early 2022 was influenced more by market trends than company performance. Continuous insider buying, coupled with minimal selling, strengthens the case for Rheinmetall as a compelling investment.
Trend Break Confirmation
This brings us to another perspective on insider buying: as a confirmation of a positive trend break. While we often view insider buying as a secret signal of impending success, it can also serve as a broader market indicator.
Experienced investors know market downturns well. My first exposure was the 1987 crash, but many recall the COVID collapse or the dot-com bubble. Warren Buffet reassures us that market downturns can present buying opportunities. The key is recognizing that buying near market lows often leads to powerful recoveries, yet fear often prevents timely investments.
Research from Putnam highlights this concept, noting that after the COVID downturn, insider buying surged, particularly in cyclical sectors poised for rapid recovery.
Putnam’s analysis suggests that insider buying can signal a market bottom, particularly when combined with other indicators, such as commodity prices. For instance, copper prices often correlate with economic activity, making them a crucial factor to consider.
Figure 2 FCX chart from 01/01/2020 to 04/2022
In summary, while insider buying is not a direct investment trigger, it serves as a valuable signal under certain conditions. Options trading can effectively leverage these signals, allowing for more nuanced market engagement. A well-researched insider buying strategy might involve purchasing a LEAP and selling short options to provide protection against market fluctuations while capitalizing on upward momentum. The poor man’s covered call is a useful strategy for insider buying scenarios.
