If the CEO or board member of a company is selling stock, should I do so too?
Not necessarily. Sure, insider selling — i.e. when a top executive, board member or big shareholder sells stock — doesn’t sound good. Why would someone dump shares unless there was some bad news on the horizon?
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That’s why shares of companies that have significant insiders sell their stock typically fall on the news.
In just the past few weeks for example, Papa John’s (PZZA) fell after founder and former CEO John Schnatter sold a big chunk of stock, while online commerce and cryptocurrency firm Overstock (OSTK) plunged after CEO Patrick Byrne sold shares.
The fear is that insiders know better than average investors what’s really going on at a company.
When most people hear insider selling, they think about the infamous Ivan Boesky trading scandal from the 1980s that inspired Michael Douglas’ Gordon Gekko character in the movie “Wall Street.” Or they think about Martha Stewart selling shares of biotech ImClone just days before the FDA announced it wasn’t approving a new ImClone drug.
But most insider selling isn’t really all that devious in nature — or illegal for that matter.
Nick Clay, a portfolio manager with Newton Investment Management, said company executives often have a legitimate reason to sell stock.
They may need to pay taxes or want to diversify their portfolio, for example. Many prominent insiders even have preset plans to periodically sell shares.
Buybacks + insider sales may be bad news
Still, there are some instances when insider selling can be a troublesome sign.
In fact, SEC Commissioner Robert Jackson has been extremely critical of companies that announce big corporate buybacks of stock at the same time that executives are selling shares.
Buybacks tend to be viewed favorably by investors because they tend to reduce the overall share count and boost earnings per share. But Jackson thinks some insiders take advantage of the price increases created as a result of a buyback to unwind their personal holdings.
“When executives unload significant amounts of stock upon announcing a buyback, they often benefit from short-term price pops at the expense of long-term investors,” he said in a letter in March, adding that “insider selling on buybacks is associated with worse long-term performance.”
Jackson added in an interview with CNN Business that “CEOs don’t sell valuable things cheaply. Executives are using buybacks as a way to cash out.”
Look more for insider buys than worrying about insider sales
But Clay said he focuses less on insider selling and more on insider buying. If a CEO, founder or board member is actually purchasing stock, that’s a show of confidence.
“We definitely want to see management have skin in the game and be willing to use their own money to buy shares,” Clay said.
So how do you find companies where insiders are buying and selling?
So you have to do your homework. Don’t automatically assume that a CEO’s stock sale is a bad thing. And identifying the companies where insiders are actually buying might help you profit in the long run.
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