Last spring, shares of Waste Management Inc. (NYSE: WMI) were coasting along in the $55 to $60 range, up solidly from a 52-week-low of $35. “Suddenly, in mid-May, there was a burst of insider selling at around $55,” says Craig Columbus, research director for Primark, a financial services firm in Scottsdale, Arizona. “The extent of this selling was much greater than it had been in the previous 12 months.”
As it turned out, the sellers had an inside track. Subsequent earnings reports were disappointing and the stock was trading below $24 by mid-August. Waste Management is now under investigation by the Securities and Exchange Commission for possible violations of securities law, including making misleading statements about earnings. The company is also facing several class-action lawsuits accusing it and its top officers of securities fraud.
Although the Waste Management example is an extreme case, insiders such as directors, officers and key executives may be sending valuable signals when they sell their company’s shares. After all, who knows more about what’s in the near future for that company? Savvy investors can use insider selling data to their advantage. Here’s how:
- Screen stocks before investing. If you’re thinking of buying a stock, check to see if top officers are selling. Columbus says such data is available on the Internet at such sites as Yahoo! Finance (http://finance.yahoo.com) and AltaVista Finance (http://finance. av.com). “You should check insider selling at the companies whose stocks you own,” says Bob Gabele, director of insider trading research at First Call/Thompson Financial in Rockville, Maryland. If such selling increases sharply, it might be a good time to sell, he says.
- Sell your holdings. Insider selling can be a clear signal to sell a stock you own or to cut back on your position.
- Hedge with options. You can buy a put option, giving you the right to sell shares you own at a set price, thus removing your downside risk in the stock.
- Sell short. You can borrow shares and sell them short, hoping for future profits by repaying the loan with shares bought at a lower price. Columbus says this is a high-risk strategy.
- Here’s a word of caution: not all insider sales are significant. Gabele notes that Bill Gates, chairman of Microsoft (Nasdaq: MSFT), sells millions of his company shares regularly, “but he owns nearly a billion shares so that’s no big deal.”
- Another main reason for selling: options expirations. Insiders will frequently exercise options and then sell the acquired shares.
But here are some of the most crimson of red flags:
- Selling from the top officers. Although all insider trades must be reported, sales by the president, the chief executive officer and the chief financial officer are the most telling.
- Sales patterns. Insiders may sell a certain amount of shares per month in order to diversify their portfolio. An unprecedented spurt of selling may be noteworthy.
- Recent stock performance. Selling an appreciated stock may be mere profit-taking but selling after a stock has fallen may be a sign of more bad news to come.