Internet, Newsletters Now Make It Much Easier to Track Insider Trends

It takes extra work to track insider buying activity--and filter out sweetheart deals--but it’s worth it for one simple reason: An insider who voluntarily scoops up shares sends one of the best signals to the market that a stock is worth buying.

And the advent of the Internet and availability of specialized newsletters mean it’s easier than ever for individual investors to track insider buying.

“There’s a ton of good information,” said Jonathan Moreland, head of InsiderTrader.com, a World Wide Web site devoted to insider activity. “Institutions have been using this for decades and paying through the nose for it. And they don’t pay through the nose for something that’s useless.”

Insiders must report buying in their own companies’ shares to the Securities and Exchange Commission by the 10th of the month following any purchase. That means investors learn of the activity within about six weeks.

The information is reported in so-called Form 4 filings. Those are the filings that newsletters track. The filings are also available through the SEC’s EDGAR database, if companies choose to post them electronically.

*

Broadly speaking, insider buying refers to managers’ and directors’ reaching into their own pockets to pick up shares in their companies at market prices.

Insiders tend to be long-term holders rather than traders, for two reasons: First, when companies pay insiders partly in stock, such as when they grant options, the companies often restrict the insiders from selling for certain periods of time. Second, when executives buy on their own, companies often frown on their dumping large blocks soon after purchase.

Legitimate insider buying shouldn’t be confused with illegal insider trading, which entails buying or selling of stock by people acting on material nonpublic information.

Insider buying at market prices also is distinct from the exercise of stock options, which often occurs at below-market prices.

In recent years, insider activity overall has been an excellent barometer of the direction of the stock market. Early last October, about four weeks before the market fell hard because of the Asian financial crisis, insider buying dried up and selling accelerated.

Conversely, just before the market rallied early this year, insider buying rose, a sign that many insiders felt their companies’ stocks had been unfairly clipped.

*

Historically, insiders sell 2 to 2.5 shares for every 1 they buy in the open market. That’s because many insiders get stock through options as well as through open-market purchases.

Lately, insider gauges have turned bearish again, with the ratio of sells-to-buys at 2.79 to 1 during the last eight weeks, said Richard Cuneo, editor of Vickers Weekly Insider Report.

How do you analyze insider activity to find stocks poised to perform well? Here are a few clues:

* Look for clusters of insider buys. It’s a good sign if a top manager picks up shares. But it’s outright bullish if several executives do around the same time, especially if they’re grabbing large blocks.

Frank Ponticello, a technical analyst at Prudential Securities Inc. who tracks insiders, looks for three or more insiders buying at least 1,000 shares within a three-month period, with no selling.

Conversely, the significance of insider buying is muted if the purchases are small. “When a CEO invests $10,000 in his company stock, that doesn’t say a lot about his conviction,” said George Shirk, managing editor of the Insiders newsletter in Deerfield Beach, Fla. “But if he’s investing $300,000 or $400,000, then it’s much more telling of his conviction.”

* If insiders are buying at one company, check to see if the same holds true at other companies in the industry. That’s a stronger buy signal because it implies that something positive is afoot throughout the sector, Shirk said.

Among industries, banking has had the most bullish insider activity for some time, Cuneo said. Though the buying activity has slowed from its feverish pace of six months ago, bankers are still buying their shares at a far stronger clip than are insiders in other fields. Insiders at utilities and real estate investment trusts also are buying.

* Look for situations in which insiders may be “early birds.” By nature, insiders are value players when it comes to their companies’ stocks. They prefer buying when prices are low, such as after a pullback. The downside is that they’re sometimes early, so stocks favored by insiders may not necessarily head up immediately.

Still, with companies that are out of favor on Wall Street, insider buying often signals that bad news is over. If a stock has suffered because, say, the release of a new technology has been delayed by repeated snafus, insider buying may signal that a launch date is finally near and that the technology looks promising.

*

Early insider buys may give investors a chance to hop aboard before a stock has begun to run up. In fact, some experts won’t buy a stock if the price has risen much from where insiders got it.

“We don’t like to pay too much of a premium from what the insiders pay,” Ponticello said.

* Look for companies whose insiders are paying up for stocks. Because insiders are value-oriented and don’t like to ante up, it’s a great sign when they do. For example, insiders at Popular Inc. (ticker symbol: BPOP), a bank holding company, and Glenborough Realty (GLB), a real estate investment trust, have in recent months bought their respective stocks even as prices were rising.

* Look at who’s buying. Purchases by top executives obviously weigh more heavily than purchases by lower-level people. The most important executive of all to watch, some experts argue, is the chief financial officer.

“This guy probably knows the numbers better than anybody,” said Phil Foreman, manager of the Composite Growth & Income stock fund in Spokane, Wash., which relies heavily on insider data in researching and buying stocks. Heavy buying by the CFO may mean he expects the company to beat earnings projections over the next few quarters.

Finally, although the focus of most analysts who track insiders is on stock purchases, what about heavy insider selling?

Because insiders often have so much tied up in their stocks, selling isn’t necessarily a reason for investors to worry, experts say.

As with insider buying, selling should be put in perspective. For example, if insiders dump shares when a stock is already depressed, that can be a sign that even deeper trouble is brewing.