Learn

How to read an insider buy

Corporate insiders sell their shares for all kinds of reasons — a house, a divorce, a tax bill, plain diversification. They buy for one.

That asymmetry is the whole reason insider purchases are worth watching. A chief executive who puts several hundred thousand dollars of her own after-tax money into her company's stock on the open market is making a statement she cannot easily walk back. She has better information about that business than any analyst covering it, and she has chosen to concentrate her personal wealth in it rather than diversify away.

It is not a guarantee of anything. Insiders are frequently early, and sometimes simply wrong. But it is real information, it is public, and most investors never look at it.

Where the information comes from

Under Section 16 of the Securities Exchange Act, three groups have to report their trades: company officers, members of the board, and anyone owning more than ten percent of the shares. When one of them buys or sells, they file a Form 4 with the SEC, generally within two business days of the transaction.

These filings are free to read on the SEC's EDGAR database. They are also the raw material behind every insider-buying screen and alert service you will encounter, including ours.

The transaction code decides everything

This is the single most useful thing to know, and it is where most people go wrong. A Form 4 carries a code describing what actually happened, and the codes are not equivalent:

P — open-market purchase. The insider bought shares at the going price with their own money. This is the one that carries a signal.
A — award or grant. The company handed over shares as compensation. The insider did not choose to buy anything.
M — option exercise. The insider converted options into shares, usually at a price fixed years ago. Often followed immediately by a sale.
S — open-market sale. Shares sold. Frequently routine, and frequently scheduled in advance.

Headlines announcing that "insiders bought $4 million in stock" are often describing grants and option exercises. Filter for code P or the equivalent open-market purchase label, and most of the noise disappears.

What separates a meaningful buy from a token one

Size relative to the person, not the company. A $50,000 purchase by a director earning $180,000 a year means considerably more than a $2 million purchase by a founder worth $900 million. Ask what fraction of their net worth this represents.
Cluster buying. One director buying is a data point. The CFO, two directors, and the head of operations all buying inside the same fortnight is a pattern, and clusters have historically been the more reliable signal.
Who bought. Chief executives and finance chiefs see the numbers first. Their purchases have generally carried more weight than those of outside directors.
Buying into weakness. Purchases made while the stock is falling say something different from purchases made after it has already run.
A first purchase in years. An insider who has only ever sold, suddenly buying, is a change in behaviour — and changes in behaviour are usually more informative than the behaviour itself.

Things that look like signals and aren't

Purchases made under a Rule 10b5-1 plan, which is scheduled months in advance and tells you nothing about what the insider thinks today. The filing discloses this.
A director buying the minimum required to satisfy a stock-ownership guideline.
Purchases by a private-equity or activist holder above ten percent, which reflect their own strategy rather than a view on near-term value.

The honest limitations

Insiders know their own business. They do not know what the Federal Reserve will do, whether a competitor is about to launch something better, or where the broad market is heading. A well-run company bought by its own management can still fall hard in a bad year.

There is also a timing problem. Insiders often buy early — sometimes very early — and a stock can drift or decline for a long stretch after a purchase that eventually looks prescient. Insider buying is best treated as a reason to start looking at a company, not as a reason to buy it.