Psst, company execs are buying their own stocks, the gurus say
Who knows more about a company and its prospects than the men and women seated in the swankiest offices? The company chieftains are privy to the daily agonies and accomplishments of their salespeople. It's their job to know when distributors are displeased. They analyze the corporate battle plans. If the corridor talk is buoyant over expectations of record profits, or fades to whispers of weak earnings, the head honchos are often the origin of such chatter.
So when these corporate insiders start snapping up stock in their own company, it may be time to follow suit. Norman G. Fosback advocates just such an action now. Forty-eight percent of the corporate insiders are buying their own company's shares, according to the editor of The Insiders newsletter, published by the Institute for Econometric Research in Fort Lauderdale, Fla.
A normal buying ratio is 35 percent. The current surge in buying has produced the best reading on his ``Insiders Index'' since January of this year, Mr. Fosback says. The January reading was followed by a strong rally, with smaller, over-the-counter issues leading the way. Again today, insiders on the American Stock Exchange and the over-the-counter market are the big buyers.
``I'm interpreting this data as a signal that the secondary correction is in its final stages,'' Fosback says. ``And I'm impressed with the magnitude of buying relative to the slight declines in the market overall.''
The average stock on the New York Stock Exchange has fallen about 7 percent since July. Still, the Dow industrials have held up well, benefiting in part from arbitrage buying on mergers and rumors of takeovers. Pace-setting IBM's report of a 7 percent decline in third-quarter profit did the market little harm Friday, and the Dow closed up 11.20 points for the week at 1,339.94.
Numerous academic studies have shown that insiders do have an edge on most investors. Fosback says, ``Stocks bought by insiders go up, on average, twice as much as the market.'' Fosback's newsletter lists individual stock trades, but is that enough to go on? Should insider trading alone be the basis of a stock purchase? Yes, says Fosback, it's possible to outperform the market over several years. But he allows that ``it's simply more prudent to use all the tools available before maki ng a decision.''
Charles Mayer of the Insider Reports Fund, a newly formed mutual fund in New York, contends that an investor needs more than one or two trades by an insider to select a stock. His fund, the only mutual fund based on insider trading, gathers and sifts through insider trading reports with a proprietary software program.
``We need to see four instances of insider buying within nine months. And we want to find out how many people, who they are, and how much stock they're buying.''
For seven years, he and Aaron Feigen have bought stocks for individual clients and sold their tracking service to money managers. ``And we found we were never able to take our top 10 stock choices and outperform a batch of stocks. The batch always beat individual picks,'' Mr. Mayer says. Thus, the rationale behind the mutual fund.
The fund now has 118 stocks in its portfolio. The fund's net asset value per share has fallen about 6 percent in its first quarter of existence. But Mayer isn't disturbed by this early dip. ``We're right in the middle of the performance range of equity funds tracked by Lipper [Analytical Services].''
Mayer points out that the fund has a long-term (six months to three years) strategy, which is essentially dictated by securities law. Corporate officers must hold their stocks a minimum of six months.
One potential flaw in insider trading as an indicator is the lag in reporting. By law, company officers must report a trade to the Securities and Exchange Commission by the 10th day of the month following the trade.
But enforcement is not strict. Insider data tend to be four to six weeks old. So insiders could be backpedaling now or buying more heavily, and it wouldn't become public for a month or more.
Perhaps a greater risk to consider is that the company officials may be just plain wrong about their assessment of their companies' prospects.
In formulating an insider strategy, remember that only insider buying is considered significant. A chief executive has a number of stock purchasing options that don't require public disclosure. So if he or she is willing to go into the public market and pay full price and commissions, that executive must have faith in the stock's upward potential.
A stock sale, however, could be motivated by excessive debt, the need for a house down payment, or tuition for children, and not simply because poor earnings are expected.
Illegal insider trading arises when the executive makes a trade based on company material not yet disclosed publicly. But the SEC definition of insider trading is so subjective, says Norman Fosback, that few cases are brought to court.
Which CEOs are buying now? Those in real estate investment trusts, banking, communications, gas and pipeline utilities, savings-and-loans, and electric utilities. Fosback says, ``These are interest-rate-sensitive stocks. That suggests insiders expect lower rates.''
Mr. Mayer's data reveal two active buying groups: insiders at banks and financial services, as well as oil and oil-drilling executives. Chart: Interest Rates. *Yields; Source: Bank of Boston.
Percent Prime rate 9.50 Discount rate 7.50 Federal funds 7.86 3-mo. Treasury bills 7.15 6-mo. Treasury bills 7.30 7-yr. Treasury notes 10.20* 30-yr. Treasury bonds 10.60*