The Investment U E-Letter: Issue # 233
Friday, April 25, 2003

Insider Buying of Stocks: The Strongest Purchasing Signal in the World?
By Dr. Steve Sjuggerud, Chairman, Investment U

There are a million reasons why a corporate insider would sell but only one reason why a corporate insider would buy

When insider buying of stocks is happening at the corporate level, it may just be an outstanding buy signal for you and me. When you find a stock that looks good fundamentally (is “cheap”), that looks good technically (is starting to move up), and that has heavy insider buying, chances are very good you’ve got a big winner on your hands, according to Alexander Green, who writes The Insider Alert. According to Alex:

When Insiders Are Buying Stocks, We Should Buy

“Insiders are the officers who run a company, the directors who oversee the officers, and 10% beneficial owners of the stock who are presumed to be more than ordinarily well-apprised of the company’s business and future prospects.

Insiders know virtually everything that can be known about the company they run. They know the pace of sales day to day. They know of new products in development. They know whether the company is a takeover candidate or is already getting unsolicited offers. In short, they know everything that reasonably can be known about their company’s business prospects, employees, customers, suppliers, and competitors.

In short, insiders have an unfair advantage when they go into the market to trade their own company’s stock shares. After all, they know not only all the public information about their company but a great deal of non-public information as well.

For this reason, the U.S. government requires all insiders to report their transactions to the SEC by the tenth day of the month following the month in which they buy or sell their company stock shares.

My philosophy is straightforward. There are plenty of reasons an insider would sell his own company’s stock that have nothing to do with its business prospects. He may be diversifying his portfolio, buying a big house, putting his kids in private school, or - for all I know - paying for the upkeep on his mistress. (Or, in fact, the company outlook may be lousy. Witness the $1.1 billion in insider stock sales at Enron in the 12 months before they filed bankruptcy.)

But, in my opinion, there is only one reason that multiple insiders are buying their own company’s stock shares. Based on their ‘unfair advantage,’ they think their shares are set to soar.

Not A Foolproof System - But Pretty Close

And while no system is foolproof, I’ve found more often than not they’re right.

Volumes of independent research validate this point of view. In fact, just a few weeks ago Business Week ran an article highlighting the same conclusion:

“A study by researchers from the University of California at Los Angeles and New York University shows that a group of insider buyers, most from tech and pharmaceutical companies, beat broad market indexes by an average of 9.6% in the six months following their purchases.”

Two important points here:

• First, 9.6% is just about the market’s average annual return over the past 100 years. Yet insiders are earning 9.6% more than the market’s return in just the first six months after their purchases.
• Secondly, remember this is merely the average gain after an insider purchase. What if you restricted your purchases to just those companies that were fundamentally sound, had a major catalyst for positive change AND heavy insider buying of stocks too?

This is a question I’ve been researching for several years and my answer is: Good things will usually happen.

As an example, let’s look to Tyson Foods for a moment. I know selling headless Rhode Island Reds is not as exciting as seeking a breakthrough in cancer treatment or the development of the next generation of semiconductors. But, it can be profitable.

Bullish On Chickens

In fact, according to Investor’s Business Daily, the U.S. company showing the second-largest increase in profitability in the second quarter was - you guessed it - Tyson Foods. In fact, its earning per share in the latest quarter were up more than 350%. And the stock has soared 84% in the last nine months.

Who could have known in advance there were such huge profits to be had selling chicken? The insiders at Tyson Foods, for starters.

A little over a year ago, directors Joe and Wilma Starr bought 15,000 shares. Then last summer, as the stock languished in the single digits, other insiders started buying stock, practically lining up at the trough. First, director Leland Tollett bought 25,000 shares. Then director Donald J. Tyson purchased a few thousand shares. Shelby Massey, another director, picked up 10,000 stock shares. In September, officer Greg Huett acquired 9,437 shares. And so on.

Let me remind you that this became public information not long after they made their purchases. No hindsight was necessary.

Investors who followed in their stock buying footsteps have seen the stock rise more than 80% since the September lows. And now that the stock has skyrocketed, insiders are no longer buying. In fact, the only insider transactions in the last three months are sells. Time to move on.

I spend several thousand dollars a year to subscribe to a service that allows me to monitor the daily electronic filings at the SEC. I then spend hours more each week looking at each insider’s track record and doing a thorough fundamental and technical analysis of each stock that looks interesting.

I wade through an avalanche of meaningless information. Like small purchases from new officers or directors who are just trying to show they’re a ‘member of the club.’ Or insider purchases that are made solely because of option compensation.

Defining Insider Stock Buying

What I mentioned above is not real insider activity. Technically speaking, insider buying is multiple insiders buying a large quantity of the stock with their own money at current market prices.

That kind of information can give you a promising lead. And some of these leads have turned out to be quite rewarding. Despite the swan dive on the Nasdaq and S&P 500 year-to-date, so far this year a trading service I run, The Insider Alert, has already locked in double- digit profits in New York Community Bancorp, US Oncology, Bio-Reference Labs, Household International, Capital Bancorp and others. Every one of these stocks had sound fundamentals and, of course, heavy insider buying before we made our purchases.

Good investing,

Steve

Today’s Investment U Crib Sheet

• According to Alex: When you find a stock that looks good fundamentally (is cheap), that looks good technically (is starting to move up) and that has heavy insider buying of stock, chances are very good you’ve got a winner.
• You can check recent insider activity on your stocks for free at finance.yahoo.com. Also, companies like www.ChartCraft.com use insider activity as a tool to guess where the market will be in 12 months’ time - it’s worth checking out. And you can also consider subscribing to a service like Alex’s Insider Alert, which finds opportunities for you with heavy insider stock buying in addition to good fundamentals and technical strength.

Related Articles:

• Insider Stock Trading: Due Diligence For “Insider” Profits
• Stock Buying Tips: Is Everyone on Wall Street an Idiot?
• Stock Market Investment Advice: “The Two Most Profitable Secrets of the World’s Greatest Investors”
• Stock Market Indicators: Profiting Now from the Two Best

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