Investors pay close attention to what executives and board members do with their own shares in a company.
The theory goes that if these insiders who know a company best are buying shares, they must have good reasons to be optimistic. So, when insiders – company officers, directors and largest shareholders—are buying company stock in a rising market like this can be a strong endorsement.
On that point, Safaricom #ticker:SCOM chief executive Bob Collymore was recently in the news for purchasing about 300,000 shares, or one-fifth of his total stock in the telco.
Other mini-insider purchases were also reported for the firm. Question is, should investors consider doing the same thing? Is following corporate insiders a wise investment strategy?
The verdict is still out there. But considering research (to-date) in this area, evidence strongly favours this approach. And here are a few arguments for chasing after insider moves.
One, having skin in the game is always an important variable in the market. Certainly, if corporate insiders are investing in their own stock with their own capital in the open market, there’s a comfort level there.
In other words, it’s a sign that the people who would best feel that their fundamentals and valuation are good are confident that the stock is going to rise over time. For investors, it’s simply reassuring to buy a stock knowing that an informed insider is doing the same thing.
Two, insiders tend to be mostly value players, so they will try and bottom-feed, buy when the stock has come down in price and sell when its gets expensive. Studies now show that high insider buying activity often coincides with good times to buy in the market.
Three, insider buying is a great validation for long-term investors. Increasing insider ownership sends a message of confidence in the company’s long-term prospects.
To give context, there is no way that Mr Collymore is buying to exit in a few months’ time.
He’s definitely thinking about the long-term benefits of the firm. Furthermore, knowing that the management has an incentive to make the company profitable in the long run is very comforting to investors.
That said, caution is warranted. One big challenge with using insider trading data on companies is that executives sometimes can misread company prospects.
Even when insiders do correctly assess their company share, it can be a matter of luck as much as anything else. Remember corporate executives can be just as foolish with their money as the rest of us.
So, just because a pattern of insider trades might offer a cue for upcoming market shifts, it should never replace diligent research. What’s more, sometimes too much insider ownership is no good. Research shows that some managers may not feel responsible to their shareholders.
Nonetheless, the overall argument for shadowing insiders makes a lot of sense. By watching the trading activity of corporate insiders, it’s easier to get a sense of a stock’s prospects.