You should consider what a company’s executive officers are buying and selling when you pick which individual stocks to buy. I think that most of us know that insider trading is illegal. Just look at Martha Stewart and traders at Galleon and New Castle hedge funds to see recent examples of insider trading, the illegal way.
Martha Stewart, the home decorating maverick, was accused of selling shares of ImClone in an insider trading scandal after learning of some impending bad news from her stock broker. The problem stemmed from her receiving preferential information before it was made public. Traders at Galleon and New Castle hedge funds have recently been accused of insider trading as well. Those professional investors were accused of earning $20 million by trading on companies from Silicon Valley that included icons such as Google, Intel, and Advanced Micro Devices.
But, have no fear. There is a way to find out legally what the CEO and other top executives are thinking about their company’s future outlook. You can find out how many shares of stock they are buying and selling which can be an indicator of things to happen in the future with the company. When a firm’s leaders buy and sell shares they have to file a “Form 4″ with the SEC, the government regulator of the stock markets, providing details of the stock trades. These forms are public information and can be searched through the Edgar Database at SEC.gov.
Yahoo Finance also does a great job of listing which executives are buying or selling shares of their company. For example, after entering a company’s stock symbol, click on the “Insider Transaction” link on the left to get a detailed report about recent trades. In October 2009, Barry Diller a member of Coca-Cola’s Board of Directors (Stock Symbol: KO), purchased 510,000 shares of the company’s stock. Is this a sign that good things are imminent? Maybe it is, but it is definitely not a bad sign when executives and members of the board spend their own money to buy shares of the company. Other great resources are the Inside-Monitor website and the MSN Money list of top ten companies with insider buying and selling.
When an executive buys large blocks of his company’s stock, it is a great signal that he thinks the company’s future is bright with wonderful growth potential. It also signals that the stock price may be undervalued in relation to what they company really thinks it’s intrinsic value is worth. Or, the company views its future earnings may be greater than Wall Street is giving it credit for. Maybe the executive in question is buying shares because of a recent R&D success that he knows about or a new product that is about to be launched that the board thinks will really spark some growth within the company.
The same can be true for when an executive sells a lot of shares of the company’s stock unexpectedly. Large selling of a lot of shares is usually not viewed as a good thing. Investors begin to wonder what that executive knows about the company’s future prospects that they do not. But, selling may not quite be exactly what it seems sometimes. Many executives receive large blocks of stock options and may just be diversifying his personal portfolio through systematic selling, and that is okay and normal. For example, Bill Gates systematically sells huge blocks of Microsoft, millions of shares at a time, but those sales are announced and scheduled in order to not give unintended signals to everyday and institutional investors.
It is the rapid, unexplained, random, and large sell offs that should worry you as a potential investor. Rain clouds may be coming the company’s way in that instance. While insider trading is not the only attribute that you should consider when picking individual stocks to buy or sell in your own portfolio, it is a good signal that can be used in conjunction with others in order to understand the broader picture and the company as a whole. Who knows more about their respective companies than their officers, directors, and large shareholders? When these people buy or sell their shares, we should take heed.