Follow the leader? Insight into insider stock buys

Follow the leader? Insight into insider stock buys
Insider purchases and sales noteworthy milestones but no road map to investing success
Dave Carpenter, AP Personal Finance Writer
Wednesday February 11, 2009, 5:21 pm EST


Yahoo! Buzz Print CHICAGO (AP) -- When a top executive buys or sells shares of his company in great number, it could be a telltale signal of what lies ahead for all investors.

But be careful before you follow in a CEO's footsteps. Knowing how much stock to put into an insider's actions, literally and figuratively, is a tricky business.

"The most important aspect that the lay investor should keep in mind is that it is a first screen," said Jonathan Moreland, director of research at InsiderInsights.com. Despite that caveat, though, "it's the best one that I know of," he added.

Assessing insider transactions is a lot more useful as an investing tool than it used to be.

That's because a publicly traded company's officers, directors and anyone who owns more than 10 percent of the shares is required to report any purchases or sales of their company's stock to the U.S. Securities and Exchange Commission within two business days. This means they can be quickly digested by investors checking the SEC Web site and any number of financial sites such as Yahoo Finance and MSN Money.

Until corporate scandals including Enron and WorldCom prompted reforms in 2002, companies had up to 41 days after transactions were made to report. Fortunes have been made or lost in less time.

The latest high-profile insider purchase to draw attention in a down market is that of Bank of America Corp. chief executive Ken Lewis, who spent more than $2 million buying 400,000 shares of his struggling bank in late January and early February.

So far, so good. Bank of America shares climbed back above $6 on Wednesday, well above Lewis' purchase price of about $5.40 per share.

These stories frequently have unhappy endings, though, for investors who try to emulate an insider's buys.

Take the case of Krispy Kreme Doughnuts Inc. Two days after the company reported its first-ever loss in May 2004, CEO Scott Livengood bought 24,000 shares at $20.77 in an apparent show of confidence. His total cost: More than $498,000, almost equivalent to a year of his salary.

Some investors believed that was a promising sign of better things to come, at a time when overexpansion and changing dietary habits had both hurt results and the stock price had been cut in half in a matter of months.

But if you bet dollars to doughnuts on it being a strong buy signal, you'd have been very wrong. Eight months of continuously bad news followed -- including plunging profits, a federal securities investigation and allegations of corporate deceit -- Livengood was out as CEO and the stock price was under $9. Today each share is worth just over $1.

Similarly, Dell Inc. CEO Michael Dell bought $100 million of the computer maker's stock last September.

Talk about bad timing. The shares lost more than half their value in 10 weeks during the market meltdown. As of this week Michael Dell had lost $55 million on the investment.

A wildly unpredictable economy like this one, in other words, makes it even harder to interpret the significance of insider transactions.

"When you see an executive put large sums of money on the line, clearly that's a signal that he feels very confident," said Jason O'Donnell, a senior research analyst with Boenning & Scattergood Inc. in West Conshohocken, Pa. "But that doesn't necessarily mean that the stock's going to go up."

While it's hard to imagine that a $100 million stock purchase like Dell's was simply window dressing or a statement to investors, it's possible that smaller purchases could be aimed largely at drumming up more buying.

Vita Nelson, editor and publisher of The MoneyPaper, a Rye, N.Y.-based financial newsletter, says executives could be playing off the widespread notion that insiders have an early read on where the company is going.

"They may hope that the publicity of their having bought will have a positive effect on the direction of the market price," she said.

Other reasons to be wary of insider purchases: They could be happening because of company requirements that require C-level executives to own a certain amount of shares. They could have been made with company loans -- check the company's SEC filings. Or the executives could just be putting company-awarded stock options to work, which would signify less of a personal commitment.

Savvy investors will view a CEO's big buy in context.

Lewis, for example, made more than $20 million in 2007, so a $2 million purchase was the equivalent of roughly a month's pay -- substantial but not exactly betting the ranch. On the other hand, he was joined by more than a dozen Bank of America officers and directors who made large purchases at the same time -- a collective vote of confidence rather than an individual one.

Insider sales should be viewed with similar caution. An investor's instinct when a top executive sells thousands of shares would be that the stock price is heading lower and it's time to follow suit. But the executive could also be selling because she needs the cash for personal reasons.

One good overall indicator is how much of a stake insiders have in their companies. In general, the more shares they own, the better for investors. So if they are selling large percentages of their overall holdings, that could be a stronger signal to jump ship.

But don't drive yourself crazy trying to assess the meaning of a big transaction if the evidence seems mixed. It's best not to view insider moves in isolation, advises Wayne Thorp, a financial analyst for the American Association of Individual Investors in Chicago.

"You're building a mosaic to decide whether you want to be invested in a company," said Thorp. "This is just one piece of the puzzle."

Securities and Exchange Commission http://www.sec.gov

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