Insider and Institutional Ownership

When investigating small companies as possible investments, it's always good to learn who else owns shares. Insiders or institutional investors are two key groups to pay attention to.

Insider holdings are generally a good thing. Executives who own 30% of a company, for example, are motivated to make it succeed. The best employees and executives work harder when they work for themselves. As shareholders, they can see a significant correlation between their efforts on the job and their compensation. Insiders buying shares is also usually a good sign, as it means they expect the shares to rise. Don't be alarmed by insider sales, though, unless there's a lot of it.

Institutions, such as mutual funds and pension funds, are the major players. They buy or sell in enormous chunks. Whether a stock is in or out of their favor can have a big effect on its price.

When small companies have little or no institutional ownership, it's often because the big players are sidelined. Small firms usually have relatively few shares outstanding, and their total worth is modest. Imagine Scruffy's Chicken Shack (ticker: BUKBUK; slogan: "Tastes Like Chicken!"). It has 20 million shares outstanding, valued at $5 each (total market value: $100 million). Institutions that might typically buy $10 million worth of shares cannot do so with Scruffy's without buying fully 10% of the entire company, something they're often prohibited from doing.

Here's where opportunity creeps in for Fools who discover Scruffy's and snap up shares early on. If Scruffy's is indeed a gem in the making, it will keep growing. In time, Wall Street will take notice. Institutions will begin buying shares, in their usual big way. All that demand will push up the price of the stock -- and Fools can clap their hands in glee.

Discovering a small but growing company with significant insider ownership (perhaps 15% or more) and low institutional ownership is a promising prelude to finding a rewarding investment -- provided all the financial measures are sound. You can call any public company, from bomb detection specialist InVisionTechnologies (Nasdaq: INVN) to shoemaker Steve Madden (Nasdaq: SHOO) to Hooker Furniture (Nasdaq: HOFT), and ask its investor relations department about insider and institutional ownership. Just remember that small companies are best suited to investors with a few years of experience under their belt. (Hooker Furniture was highlighted in Tom Gardner's Motley Fool Hidden Gems newsletter in August and has advanced some 40% since then.)

You can learn more about how to evaluate companies in our Fool's School. A more systematic and interactive way to learn about various investing topics is via our highly regarded online seminars. (Check them out -- we stand behind them with money-back guarantees.)