The Surprising Signal That Provides "Superior Information to Investors"
Since hitting a 12-year low in March 2009, the Dow Jones Industrial Average has nearly doubled. But now, a steady stream of pundits are calling for a market pullback (with one columnist even urging investors to "move to cash and wait out the storm").
Investors trying to make sense of conflicting signals got some troubling news last week. Mark Hulbert, MarketWatch columnist and founder of Hulbert Financial Digest, wrote that "corporate insiders continue to sell shares of their companies at a well-above-average pace." Hulbert quotes data from Argus Research showing that the sell-to-buy ratio among insiders is 6.56-to-1.
Though he cautions that insiders don't always have the Midas touch, "more often than not they turn out to be right, which makes sense given their access to inside information and insight. Bulls, take note."
Channeling Peter Lynch
Cheer up, though: A year-old research paper "Are CFOs' Trades More Informative than CEOs' Trades?" by Weimin Wang, Yong-Chul Shin, and Bill Francis contains a silver lining.
Peter Lynch's oft-cited line is a good summation of why: "Insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise."
But, as the title of the paper suggests, all insider buying is not equal. The study found that "purchase transactions by CFOs, compared to CEOs, provide superior information to investors." How so? By combing through two decades of insider transaction information:
CFOs earn statistically and economically higher abnormal returns following their purchases of company shares than CEOs. During 1992-2002, CFOs earned an average 12-month excess return that is 5% higher than that by CEOs. The superior performance by CFOs occurs notwithstanding controls for risk factors, and persists even after their trades are publicly disclosed.
The authors suggest a few reasons, but I like Nell Minow's conclusion: "I think CFOs are just more motivated. Every dollar they make on the stock matters more to them because of the monumental differential in the amount and kind of pay they receive."
This isn't just a novelty, either. The paper argues that "risk-adjusted abnormal returns are still obtained after CFO trades become public knowledge via SEC filings."
One important distinction: The outperformance took place after open-market purchases. Although combing through SEC filing data can be daunting, these two tricks will ease the burden:
- Insider buying and selling is disclosed on SEC Form 4. You can search directly at http://www.sec.gov, but Form 4-specific sites http://www.secform4.com or http://www.form4oracle.com are likely easier to comb through.
- On the filing, in table I, section 3, "Transaction Code," what you're looking for is a "P." P = open market or private purchase of non-derivative or derivative security.
I'll be honest. As Hulbert pointed out, most insiders are in a selling mood right now, and I had a tough time finding meaningful open-market purchases among CFOs in recent months. After combing through a ton of company filings, however, I found three worth sharing.
Valeant Pharmaceuticals (NYS: VRX) hired Goldman Sachs alumnus Howard Schiller to be its CFO in December 2011. Since joining the company just four months ago, Schiller has made open-market buys on seven different occasions. In my research, I could not find a CFO who has accumulated more shares on the open market in the past six months.
Between those open-market buys and grants, options, restricted stock, etc., Schiller now owns 136,800 shares of Valeant, valued at more than $7 million.
By contrast, Terex (NYS: TEX) CFO Phillip Widman has been making slow and steady purchases. According to the Form 4 filings, Widman's buys are via "payroll deductions through the Company's Employee Stock Purchase Plan."
Last Friday, it was 50 shares -- the same size of his February purchase. In January, Widman picked up 73 shares ... in December it was 68 shares ... in November, 67. You get the idea. All told, Widman owns nearly $9 million of Terex stock -- some 377,000 shares -- but importantly, he's adding to his stake every single month.
Mark McGettrick is CFO and executive vice president of Richmond, Va.-based Dominion Resources (NYS: D) . McGettrick has been Dominion's CFO since 2009, although he's been at the power utility since 1980.
On Jan. 31, McGettrick disclosed an open-market acquisition of 5,000 shares of Dominion stock (at around $49 -- roughly where it's trading right now). In August, McGettrick bought 6,000 on the open market (at around $46). All told, he owns $11.6 million worth of Dominion stock -- nearly 228,000 shares -- according to S&P Capital IQ. (To be clear, open-market purchases are likely a small percentage of that stake.)
Add it up
I'm going to track these three stocks with a CAPScall, but let me be clear: Investing should never be boiled down to a single variable.
Still, take notice: The academic research is compelling, and the next time you begin screening for stock ideas, this could just be an unusual, but profitable, starting point.
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At the time this article was published Brian Richardsis managing editor of Fool.com. Follow Brian on Twitter:@brianlrichards. Brian doesn't own shares of any companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of Goldman Sachs and Dominion Resources. The Motley Fool has adisclosure policy.
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