Issue #34: Why Following Insiders Works
The market’s real signal isn’t on a chart. It’s buried in insider filings.
Reading time: 4 minutes
Every day, corporate insiders like CEOs, CFOs, directors, and large shareholders buy and sell stock in the companies they manage. Most investors overlook these trades. But that’s a mistake.
Insider transactions can reveal how confident these people are in their own business. In this issue, I’ll briefly explain why this deserves your attention and how to track these moves using free tools.
As 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 go up.”
And that’s completely logical.
Insiders sell shares for many personal or logistical reasons that have nothing to do with the company’s fundamentals. They might sell to diversify their portfolio, cover taxes, buy a home, pay tuition, settle a divorce, or simply cash in on stock-based compensation.
Therefore, a single insider sale (or even several) doesn’t automatically mean trouble.
An academic study “Estimating the Returns to Insider Trading” by Jeng, Metrick, and Zeckhauser analyzed over 20 years of insider trades and found that insider selling does not produce abnormal returns.
In fact, once adjusted for stock characteristics like momentum and value, the returns from insider sales were statistically and economically insignificant, which means they were in line with the overall market.
Now, insider buying, that’s a whole different story.
Why would you put your own money into a company you already work for, whose performance you already depend on, and whose risks you know better than anyone else?
There’s really only one reason to do it: you believe the stock is worth more than what the market thinks.
And when that belief comes from someone with inside access to future product launches, cash flow forecasts, deal pipelines, or regulatory decisions, you’d be wise to pay attention.
Although one insider buy can be incidental, a cluster of purchases, especially when it involves multiple high-level insiders like the CEO, CFO, and other C-suite executives, is what's important. The coordinated activity means consensus.
That same study by Jeng, Metrick, and Zeckhauser found that
Insider purchases earned more than 50 basis points per month in abnormal returns.
About 25% of those gains occurred within the first five days after the trade.
Roughly 50% of the gains showed up within the first month.
In other words, if you followed insider buys, on average, you’d outperform the market by over 6% per year.
And they weren’t the only ones to find that pattern.
Lakonishok and Lee (1998) studied thousands of insider trades across NYSE, AMEX, and NASDAQ from 1975 to 1995 and found the same pattern: insider purchases consistently predicted strong future performance, especially in small-cap and lesser-known stocks.
Their analysis showed that stocks with extensive insider buying outperformed by as much as 7.2% over the next year, even after controlling for factors like size and book-to-market ratios.
So, where can you actually track these insider trades?
The raw data comes from the SEC’s EDGAR database, where insiders are required to file a Form 4 within two business days of a trade. But EDGAR isn’t the easiest place to navigate. A much easier alternative is Finviz, which offers a clean dashboard of recent insider buys and sells, along with insider titles, trade sizes, and dollar values.
Let’s look at two recent examples.
On April 3, the CEO at GameStop (GME 0.00%↑) bought shares at around $21.55. As of May 21, the stock was trading at $28.05, a gain of over 30% in just seven weeks.
Another example: on May 16, the CEO at UnitedHealth Group (UNH 0.00%↑) bought shares at $288.57. Just five days later, the stock was trading at $302.98, up about 5%.
And as a cherry on top, here’s one more signal to watch.
Total insider buying across the market can point to major bottoms. When insiders across many companies are buying, it signals that stocks are undervalued and due for a rebound.
You can track this on GuruFocus, which shows the insider buy/sell ratio. When the ratio rises above 1, it's a good time to enter the market.
The free version comes with a three-month delay, but it's still helpful.
Thank you so much for reading! See you next week.