Don’t Let Insider Sales Lead You Astray

As markets approach their February highs, reports indicate insiders—CEOs and other executives—are selling shares of their companies’ stock. Whenever this happens, it prompts financial journalists and others to question whether individual investors should broadly do the same, presuming corporate executives have unique insight. However, this oversimplifies the issue, and in our view, normal folks shouldn’t factor insiders’ moves into their own decisions. They aren’t a timing tool.

One reason insiders’ sales are gaining so much attention is that the founder and CEO of a certain online retail behemoth rhyming with Pentagon sold over $3 billion of his shares in early August.^[i] (For perspective, this leaves him with a $173,543,851,365.12 stake.)^[ii] More broadly, by some measures, the ratio of insider buying to selling is the lowest since 2000, seemingly in stark contrast to insiders’ big buying in March. Considering this bull market began March 23, some believe the flurry of buys illustrates their foresight.^[iii] This creates the perception that executives must know something the rest of us don’t—leading them to jump out at an optimum exit point. It also adds to a general bout of an investor malady we term “Breakevenitis”—the urge to sell once stocks retrace prior declines in order to avoid the proverbial second shoe to drop.

Many think corporate insiders are especially sensitive to whether their firms are over or undervalued. By virtue of their unique vantage point and their job of leading their firms through changing business cycles, insiders are naturally privy to their industries’ inner workings. Who better to understand a company’s performance drivers than the executives holding the reins? And why would they sell if they aren’t pessimistic on their own company’s or the market’s foreseeable future?

As it happens, there are a lot of other reasons. Insiders aren’t too different from typical investors. Just like anyone else who follows a financial plan, they may want to diversify overly concentrated holdings. Many have stock-based compensation plans, which lead them to build up large positions in their company’s stock—a general no-no, in our view, no matter how successful your company or positive your outlook is. They may also want to access cash to make purchases or meet other financial obligations. They could also be eyeing philanthropic endeavors, real estate deals, gifting or any number of alternate uses.

Their sales' timing may have less to do with finding an optimal exit point than following regulatory procedure. Insiders are subject to lockup periods and selling windows on their corporate stock. To comply with insider trading rules, insiders must plan their stock sales in advance and on a regularly scheduled basis. However, SEC rules allow insiders to cancel planned trades. It doesn’t seem unreasonable to us that insiders may have delayed plans to diversify or take action during the February – March bear market, not wanting to compound pressure on their stock or add to fear over their company’s health. With this less of an issue now, sales have resumed, perhaps boosted by a backlog of canceled sales.

Fears over insider selling strikes us as another example of the Pessimism of Disbelief—the constant search for reasons the rally is false and soon to fade—quite common as bull markets gain their footing. This can lead to a crucial mistake. If you sell out of stocks and miss a big run-up, you may forgo the returns necessary to meet your long-term financial goals. So when confronted with supposed negatives like insiders selling, it is important to take a step back and think critically.

For one, it isn’t as if markets are unaware of executives’ activities—they price all widely available information, including insider sales, which are disclosed in advance. Once those sales are announced, markets reflect them near instantaneously. To turn bearish because of transactions that are already old news to stocks disregards how markets work. Stocks look forward, typically to a company’s earnings prospects over the next 3 – 30 months and how reality fares against those expectations. Insider selling has little bearing on a company’s longer-term earnings outlook. But also, we think getting successfully defensive requires you to see a probable growth-ending negative that others miss—and therefore isn’t reflected in prices. Selling because of insiders’ actions is speculating that they are doing so because they know something others don’t. It is a guess at their motivation—and generally a poor investing thesis.

Don’t spend energy fixating on how corporate executives are managing their own financial plans. Focus on your own plan instead, and remember that one of the biggest risks an investor faces is the risk of not reaping the market-like returns necessary to reach their long-term goals.