Inside Information
Of all the factors that investors consider when determining which stocks to own, the level of buying by company managers and directors in their own shares has long been one of the most important.
Insiders understand their companies’ prospects better than anyone else. So if they’re shelling out their personal funds to buy shares, they must feel pretty good about the outlook. And it would seem that investors who follow insiders into those stocks are bound to make money.
At least, that’s the theory. Unfortunately, it doesn’t always work out that way.
Increasingly these days, insiders are buying because their companies are forcing them to load up on shares. In other cases, companies offer managers sweetheart deals to buy stock.
Either situation may be a big red flag for investors scouting for clues about stocks: Insiders may be buying more because their jobs require it--or because they face little risk--than because they expect their stocks to rise dramatically. What’s more, some firms use insider buying as way to boost their stocks. Aware that Wall Street pays attention to insider activity, firms may trumpet big buys in news releases.
“You really have to be careful when you’re looking at insider buying,” said Bob Gabele, president of Fort Lauderdale, Fla.-based CDA/Investnet, which tracks insider activity. “It’s very important to determine to what extent corporate influence has come into play.”
Some corporate mandates require that executives own a certain number of shares based on their salaries or job titles. Companies say such rules assure that managers think like shareholders.
At other companies, managers are given incentives to buy, such as company loans with favorable terms or protection from losses if stock prices drop. Those carrots are especially common at companies that encourage, but don’t require, insiders to buy shares.
The special deals, companies say, simply make it possible for executives to afford large chunks of stock that sometimes total several times their annual salaries.
To be sure, there’s nothing wrong with requiring heavy insider ownership or offering inducements to make it happen. In fact, the stocks of some companies with those programs have logged solid gains in the last couple of years.
The problem for investors, however, is that they can no longer assume that insiders are buying because they’re bullish. Instead, investors must search for the reasons behind the purchases.
“It’s getting murkier because of those programs,” said Richard Cuneo, editor of Vickers Weekly Insider Report, published by Argus Group in New York. “It requires that people do additional analysis to find out from the companies how the programs work and if investors have anything at stake or if they’re just being handed the shares.”
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There are no exact statistics on how many companies have either mandatory or assistedstock-purchase programs. But it’s clear the number is growing. “It’s like going out on a beach with a metal detector,” Gabele said. “Every day, we find a few more rings.”
Consider Darden Restaurants (ticker symbol: DRI), which owns the Red Lobster and Olive Garden chains. Last June, the Orlando, Fla.-based company set new rules requiring that its chief executive own stock worth four times his base salary within seven years. Other managers were now required to buy shares ranging from half to three times their salaries.
But here’s the sweetheart part of the deal: The executives could borrow from the firm, at market interest rates, up to 75% of the values of the shares purchased. As an added incentive, Darden handed out two options for each share purchased, providing the potential for a windfall if the stock did well. Not surprisingly, 54 of 63 eligible managers took advantage of the program and scooped up 185,142 shares in late July. At the time, the stock traded at roughly $9 a share. It now changes hands at $16.44.
Though the stock has since fared well, Gabele said investors at the time could put little credence in Darden’s insider activity. “That’s an outside influence,” he said. “They’re getting some gimmes here.”
Rick Van Warner, a company spokesman, counters that the program was risky for the executives because they had to pay back the loans and would have been on the hook had the stock gone down. “People ultimately are paying for this out of their own pockets,” he said. “It wasn’t a giveaway.”
Another example: Baxter International Inc. (ticker symbol: BAX) executives who bought shares through a 1994 program and held on for at least three years were partly protected against any drop in the stock price.
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Baxter, a medical products company, gave loans to 63 insiders who bought 4.7 million shares at an average price of $26 a share, said Deborah Spak, a Baxter spokeswoman. For those who held the shares for three years, Baxter would cover half of any loss when the executive finally sold. If the company covered a loss, the payment would be considered taxable income. So, in effect, the insider would be liable for about 75% of any loss, Spak said.
If the shares went up--as they have, to $53.50 now--insiders who stayed the course for three years would get to keep the full gains. What’s more, when the holding period expired last June, the insiders got options to induce them to keep their shares.
“These guys are risking five or six times their annual income,” Spak said. “To incent them to take that sizable of a risk, the company offered to cover a portion of the downside risk. But in essence, they’re still responsible for 75% of the downside risk, and 75% of five or six times your annual income is a significant amount of money.”
True. Nonetheless, outside investors buying Baxter stock might wish that they, too, enjoyed some kind of downside protection.
At some firms, insiders aren’t formally required to buy shares. But because opting out could damage their chances for advancement, they really must sign on, experts say.
The most troubling aspect to Gabele and to other insider-trend trackers is the blaring of company-mandated or -assisted insider buys in news releases. “Many times, these types of buys come announced by a corporate press release [that says]: ‘Our insiders are buying. Everything is great,’ ” Gabele said.
Not surprisingly, the press releases often fail to reveal details of the programs. That makes it tough for investors to gauge just how good a deal insiders are getting.
Experts advise calling the investor relations department of any company with significant insider buying and asking about any incentives or requirements. A sure tip-off to such a program, experts say, is if an insider buys an odd lot, such as, say, 10,133 shares. That could be the exact number someone must buy to fulfill a stock-ownership rule.
Walter Hamilton can be reached by e-mail at walter.hamilton@latimes.com
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Insider Newsletters
Information on three newsletters that track insider activity:
CDA/Investnet Insiders’ Chronicle
* Annual subscription: $395
* Phone: (800) 243-2324
* Frequency: Weekly
The Insiders
* Annual subscription: $95
* Phone: (800) 442-9000
* Frequency: Twice monthly
Vickers Weekly Insider Report
* Annual subscription: $176 (three-month trial: $49.94)
* Phone: (800) 645-5043
* Frequency: Weekly
Source: Times research
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Insider Favorites
These stocks are among those currently rated highest for insider activity by the Insiders newsletter of Deerfield Beach, Fla. The chart shows the number of insiders buying and selling over the last 12 months and last three months, the price range paid by the insiders who bought over the last three months, and the number of shares purchased in that period. Of the 10 companies listed here, only Stifel Financial said it has a program that requires or assists insider purchases. *--*
No. of insider Ticker buyers/sellers last: Shares bought Prices Company symbol 12 mos. 3 mos. last 3 mos. paid MedPartners MDM 13/1 13/0 337,586 $7.50-$10.63 Tricon Global Rest. YUM 8/0 2/0 8,000 26.25-28.19 Stifel Financial SF 10/1 8/0 30,944 13.12-14.12 Topps TOPP 8/1 6/0 97,700 1.53-2.44 MascoTech MSX 6/0 6/0 100,850 18.31-20.94 Popular BPOP 13/1 8/0 15,013 46.50-51.65 Schnitzer Steel SCHN 7/1 7/0 22,100 22.94-24.81 Cayenne Software CAYN 8/1 4/0 131,500 1.64-1.85 Quality Systems QSII 6/1 4/0 23,500 6.50-7.50 Acme Metals AMI 6/0 5/0 9,500 9.88-10.38
Mon. stock Company close MedPartners $10.69 Tricon Global Rest. 31.63 Stifel Financial 18.25 Topps 3.03 MascoTech 24.00 Popular 65.22 Schnitzer Steel 26.25 Cayenne Software 2.06 Quality Systems 7.75 Acme Metals 8.94
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Source: The Insiders
