Investing Hacks: Should You Follow Insider Trades?


If you think about it, Financial independence is really just a life-hack.  A really cool life-hack.  It might even be the ultimate life-hack.

Life hacks, to put it simply, are popular.  Every blogger loves to write about them.  There’s been countless posts devoted to saving time, saving money, and making your life a little better.  And that’s fantastic because a few of them actually work!

But not all of them.

If there’s a category of ‘hacks’ I think gets too little attention, it’s investing hacks!  After all, there’s two pieces of the puzzle that need to fit together before you can reach financial independence — Saving AND Investing.

Probably the most touted investing hack in history is index investing.  That one has gotten a lot of press (for good reason), and it’s made investing way more accessible to the layman.  Everyone’s doing it ‘yo!

But it’s not the end-all-be-all of investing hacks.  There are in fact other investing hacks that exist!

Today, I’m going to discuss one of the oldest investing hacks ever… and I’ll finally revisit the story about why I bought that First Industrial 9-bagger.

 

The Theory

One the oldest investing hacks of all time is “following insider trades”.  It’s been around since the beginning of public capital markets… but what exactly is it?

The idea is quite simple really — you invest when certain investors called ‘insiders‘ also invest.  When they buy, you buy.  When they sell, you sell.

This is the investing equivalent of looking over the shoulder of “the smart kid” during a school exam.  If you follow along with insider’s moves, the idea is you’re bound to do pretty well.

Insiders are the executives, officers, and directors of a company.  The individuals with enough power, position, and information to presumably make very informed investment decisions.

In theory,  insiders will make better investments in company stock because of their unique ‘inside’ knowledge.

In the U.S., these ‘insider trades’ can be tracked via SEC form 4 filings.  Use that SEC link to search for Form 4 filings in your favorite public companies.  Be certain to click on the “Include” checkbox under the Ownership filter.

insider ownership checkbox
Click on the “include” checkbox under the Ownership filter to see Form 4 filings.

The Form 4 document is required to be filed with the SEC a few days after an insider makes a trade.  Just by watching these filings with regularity, we can get a very clear picture of how company insiders are trading company shares.

Sounds like a cool investing hack, right?

That’s the theory… but as I’m often fond of saying: Theory and Reality are two entirely different things.

 

Wrinkle #1: Securities Laws

Turns out there’s a wrinkle in this investing hack — Securities laws in many countries prohibit insiders from trading on ‘secret’ information.  Executives are not legally allowed to trade shares based upon non-public information.  It’s fraud and a breach of fiduciary duty to shareholders.  Insiders can face both civil and criminal penalties if they’re caught doing it.

However, in practice it might still be happening — Just recently I saw a news report that Intel CEO Brian Krzanich sold $11 million in shares before the Meltdown and Spectre CPU bugs were publicly disclosed.

Hmm… if that transaction was yesterday’s fridge leftovers, it would definitely smell funny.  Did he violate securities laws?  It’s hard to say, but at some point I think the courts are going to decide.  It definitely looks bad.

My point is — insider trading probably still goes on, but it’s often quite subtle.  One frequently used trick to get around these security laws are automated trading rules.  These rules are setup in advance and cause the buying or selling shares without direct insider control.

This isn’t quite as fast as selling shares when you find out there’s a massive bug in your company’s computer chips, but it will probably keep you out of jail.

 

Wrinkle #2: Taken Out Of Context

The problem with most insider trades is that we lack context for what the insider is doing.  The executive could be selling shares to buy a new yacht for Christmas, or buying that island in the Bahamas.  Or he/she could be dumping shares because they have no faith in the company.

Without context we just don’t know the real reason why an insider might be selling.  There’s plenty of legitimate reasons why an insider could sell shares in his company — one of the most important of which is portfolio diversification.

When you work at a public company, do you put your entire net worth into the shares?  No, probably not.  More than likely you own a few shares of your employer, but you also diversify your holdings into other investments.

It stands to reason that insiders do the exact same thing. 

sailboat
Insiders could be selling share for any number of reasons.   Yachts don’t come cheap you know!

This reasoning covers most insider sales, but what about insider buys?  That’s a very different story!

When an insider puts his own personal cash into company shares, there’s only one reason why he might do it — To make money.

(Sticklers will point out there’s one other possible reason why an insider buys — Many company bylaws now require executives to own a certain number of shares.  A newly appointed executive or company director might need to buy shares to meet those requirements.  Technically though, they’re still buying shares to ‘make money’.)

Unfortunately, true insider buys where an executive uses personal cash is quite rare.

 

Wrinkle #3: Just Employees

Sadly, many insiders are only only token owners of company stock.  They might only maintain a million dollars in shares, but their actual salary is in the tens of millions and private net worth is in the hundreds of millions.

That’s what I call not-significant.  This is the difference between an owner and a employee.  Many executives today are merely employees.  They are there for the salary, and are not large owners of the company.  Often times CEO’s hold considerably less than 1% of a company’s shares.

c suite job
Just because an insider holds a ‘C’ suite job, it doesn’t always mean they’re a large owner of the company.

This leads to another wrinkle in the insider invest hack — You don’t want to be following the trades of an executive with very little “skin in the game”.

These days, insiders very rarely hold a significant number of company shares.

Instead, they work for shares in the form of stock compensation plans.  This is the most common way executives acquire company shares — as part of annual grants or stock option plans.  This way they avoid entanglement with securities laws, and can frequently “buy” shares at a significant discount to market price.

Rarely do these compensation plans lead to significant (10%+) ownership in company shares — The options are executed and shares are sold almost immediately.

 

A Counter Example: My FR Story

So now that I’ve totally poo-poo’ed on this idea of investing with insiders, I’m going to give a counterexample from my own portfolio.  A time when watching insiders actually worked out really really well.

Back in December, I wrote the first part of this story in my post entitled “Let Your Best Investments Run“.  I was buying up shares of First Industrial Real Estate Trust  back in 2009, at very cheap prices.  This was during the height of the Great Recession, and I rode those shares to nearly a 900% return.

The part I didn’t tell you was why I had the confidence to quadruple-down on a stock that was falling like a skydiver without a parachute.

I was watching company insiders, and one insider in particular — Jay Shidler.

Don’t worry, you’ve probably never heard of Shidler or The Shidler Group before.  Nor have you probably heard of the five public companies he’s spun-off from the Shidler Group.  The man is practically a legend in the Hawaii real estate community, and is known for making shrewd real estate investments.

The University of Hawaii’s Business School is named for Shidler, and he’s often listed as the richest resident of Hawaii.  But hardly anybody has heard of him.

Usually guys like this sell shares to the public when their companies IPO, but here he was buying millions of shares on the open market during the Great Recession.  Essentially buying up real estate for pennies on the dollar.

I paid attention.

fr craters
Shares got really really cheap in early 2009, and insiders like Jay Shidler loaded up.

Over the span of a few months in early 2009, Shidler purchased nearly 4 million shares of FR at prices ranging from $2-$10.  One particular transaction of his made me sit-up straight and go “Oh damn!  This is the time to buy!”

So I did.  If anyone could save the troubled company from death, it was going to be him.

Let me be very clear though — situations like this are exceedingly rare.  Most of the time I completely discount minor stock transactions from company insiders.

Why?  This is what I call Wrinkle #4:  Most insiders are NOT good investors.

They might have inside information, but insiders are human too.  Most of the time they’re not any better at investing than the rest of us hopeless schmucks.  They sell at the wrong times, and succumb to market emotion just like any other retail investor.

It’s only the very rare bird that’s a true investor.  When they sing, pay attention.

 

Conclusion

So, do I use this classic investing hack and follow insider trades?  No, not really.  Only once in a blue moon do I see something interesting happening.  It’s quite rare.

While I do watch the insider trades of companies I’m interested in, most of the time it’s useless information.  I prefer to make certain insiders have the right incentives.  It’s a far more reliable indicator of future performance.

Don’t get me wrong, the theory behind the insider investing hack is a good one.  In practice though, there are far too many issues with it to be useful with any frequency or regularity.

It might have worked well at one time (before insider trading laws existed), but today insiders rarely trade shares on the open market.  Most of their money is made in other ways — Salary, stock options, and compensation plans.

That’s probably a really big hint about what matters most to insiders.

Have you ever invested with insiders and realized amazing profits?  Please share your experiences in the comments!

 

[Image Credit: Flickr1, Flickr2]

 

22 thoughts on “Investing Hacks: Should You Follow Insider Trades?

  • January 13, 2018 at 4:45 AM
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    No not only have I never witnessed insiders realizing amazing profits, I don’t think I even know any insiders. I’m a peasant 🙂

    I love reading your blog because you give such great investing tips that part of me wants to do, but a slightly larger part of me doesn’t. At heart I’m still a lazy, loafing investor who doesn’t want to lift a finger. But sometimes I read your stuff and say “man, I’m smart. This is a great idea. I should do that, I’ll make a killing!”

    Great post, let’s just hope Martha Stewart does not read this and get any fresh ideas….

    Reply
    • January 13, 2018 at 12:47 PM
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      See, you did know an insider! 😉 Mrs. Stewart is a good example of how insiders can find themselves in jail if they do things wrong.

      Apparently the SEC investigates about 50 cases of illegal insider trading per year.

      Reply
  • January 13, 2018 at 5:41 AM
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    I usually don’t pay attention to what insiders are doing. That said, I did this once in 2016 and made an easy double in a couple months.

    It wasn’t the insider I noticed. It was his wife. This particular board members wife invested a relatively small position in Cheniere at the bottom in March of 2016 and I followed suit. I can’t find the article that reported this anymore or else I would share.
    Turning Point Money recently posted…2017 Net Worth Review: Bye Bye to a Fantastic Year! +$413,030

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    • January 13, 2018 at 12:53 PM
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      Cheniere … that was a good pick. You probably should have held onto that position! Some of the new trains are opening this year, and natural gas prices are (currently) up.

      I didn’t mention it in the post, but a lot of times insiders will disclose the holdings of their family members in the Form4 footnotes. Those are almost more telling than the filing itself.

      I had not heard about that particular insider transaction with Cheniere, but it stands to reason that said board member would stop his wife from investing if the investment was bad.

      Glad it worked out for you!

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      • January 13, 2018 at 5:00 PM
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        I still hold a nice block of Cheniere even though I trimmed some shares. I believe this will be a good investment for years to come.

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  • January 13, 2018 at 5:58 AM
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    I have followed quite a few insider trades. But, they where never reason for me buying those stocks. I use them to reinforce my own conclusions. If I find too many insider sales, I would end up not buying it. Nowadays I am mostly into index funds, I don’t care anymore.

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  • January 13, 2018 at 6:17 AM
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    Your points cover the reasons I usually don’t pay much attention to what insiders are doing. There is just too much noise to throw you off. However I do believe we need to watch what certain people do and when I say people I mean certain owners or investors with the reputation for getting things done and or building great companies. I will be keeping an eye on this Jay Shidler and doing a little more research. Other such people like him that come to mind are possibly Jeff Bezos, Elon Musk, Jack Ma, Larry Ellison, Bill Gates, Warren Buffet, etc. These are the type people that have true passion for their ideas and businesses and we need to pay attention. Unfortunately most of their high flying stocks are tough to invest in for a value investor.

    Reply
  • January 13, 2018 at 7:19 AM
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    Oh cool! I can definitely see how this could work. Following the smart people can yield great results because they are smart and might know info that we don’t. I’ve heard about cases where people end up in jail for insider trading, but I honestly don’t really know how it works in real life. Great post!

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    • January 13, 2018 at 12:56 PM
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      It sounds cool, but in practice it’s extremely hard to implement. Thanks for your nice comments as always Mrs. FAF

      Reply
  • January 13, 2018 at 7:23 AM
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    I never heard of The Shidler Group. It makes me think of Duce Bigalow or something because that’s the name of the gigalow hahaha.

    Where did you catch Shidler’s making real estate trust purchases? I didn’t think they would make it public (to deter insider trading in the first place.)

    Reply
    • January 13, 2018 at 12:58 PM
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      The Form 4 filings are all public. For companies that I’m interested in, I watch all SEC filings.

      Sometimes it pays off, but it’s rare.

      Reply
  • January 13, 2018 at 7:44 AM
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    I would say the other issue with following insiders is that by the time you have seen the trade the price has probably adjusted so you don’t get the full effect.

    But cool story about Shindler, it’s definitely worth knowing about a couple of people like that that not many people know about.

    Reply
    • January 13, 2018 at 1:00 PM
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      Any time you enter into an investment with partners you should have a pretty good idea of who those partners are.

      That’s my feeling at least. Doesn’t matter if it’s a private business, rental real estate, or even public stocks.

      Reply
  • January 13, 2018 at 7:51 AM
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    I was an insider at a Fortune 500 company which limited my ability to trade to just a few weeks in any given year. I also did not believe in holding onto any options but dumped stock at every chance I had because owning your own company stock is too many eggs in one basket. So all my selling meant was that the blackout window had been lifted and I was taking all the money off the table I could. The only time I tried to time things was when I chose not to sell in a December because I was about to retire early and if I sold in January I’d be in a better tax bracket. That brilliant move cost me $60k as the options went underwater before I could execute them. In short I think most insiders are getting money for personal reasons or getting it as soon as possible and are not basing their decision on the health of the company or its profits.

    Reply
    • January 13, 2018 at 12:45 PM
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      Thanks for the comments Steveark! This backs up many of the points I made in the post!

      Reply
  • January 14, 2018 at 10:42 AM
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    As much as I’d love to follow in Martha Stewart’s footsteps, I’ll pass. 🙂

    For any kind of hack that requires luck and following other “smart” people, by the time you find out about it, it’s already too late–too many people have piled in already. Also, I just got out of corporate prison, I don’t need to get into actual prison.

    Cool take on a controversial topic!

    Reply
    • January 14, 2018 at 2:26 PM
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      There appears to be some confusion here FIRECracker. Following insider trades is not illegal as you implied. What is illegal is an insider giving a tip about his/her company that you profit from.

      You would not find yourself in prison by following the trade of an insider. Regardless, I don’t recommend the practice. Hope this clears up the confusion.

      Reply
  • January 15, 2018 at 11:09 AM
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    I believe it’s largely overrated. As an insider of a large Corp, though not a big enough fish to be reported on in the papers, I’d like to point out the biggest problem here. Insider trading laws. As an insider you have to setup stock trades months in advance to avoid being out of compliance with insider trading laws. That means for the most part an insider is buying or selling with info dated months ago. Given how fast paced the world is I don’t take much stocks in 6 month inside info.
    FullTimeFinance recently posted…Constructive Criticism and Financial Privilege

    Reply
    • January 15, 2018 at 11:37 AM
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      Yes! Exactly my point in Wrinkle #1. The laws make it essentially useless information!

      Reply
  • January 15, 2018 at 11:34 AM
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    I have never paid attention to insider trading so this is an interesting topic. I have looked at if any of my companies’ execs are selling/buying company stocks here and there just out of curiosity. I haven’t really figured out a trend yet.

    Reply
  • January 15, 2018 at 12:46 PM
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    Interesting post. I agree most of the time insider trades are unhelpful. I do tend to look for insider buys, especially if multiple and in large amounts, for stocks that have fallen in price before buying to see if the insiders still have faith in the stock.

    Reply

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