When you're looking for insight about a particular stock, the logical place to look is to the executives and other insiders who run the company. Often, the way insiders are reacting to their company's ups and downs tells you far more about their true feelings about its future prospects as an investment than their actual words will.
During periods when insider selling is on the rise, as we've seen lately, many investors draw the conclusion that stocks in general are overpriced. But there's a huge factor influencing executives' decisions about selling their company shares that could push insider sales even higher still between now and the end of the year.
High now, going higher
September's powerful rally turned many market skeptics into believers. But it had the opposite effect on corporate insiders. According to figures from Vickers Weekly Insider Report, insider sales outnumbered purchases by more than a 5-to-1 margin last week. That compares with about an even split of buying and selling back in late August. Sales by insiders at Cogent (Nasdaq: COGT ) and GameStop (NYSE: GME ) topped the $50 million level, and CSX (NYSE: CSX ) also saw significant sales following its strong earnings report.
Before you read too much into those figures, though, it's important to understand that insiders have plenty of reasons to sell shares. One is that major shareholders, especially company founders, often need to make frequent sales to diversify their investments and cover living expenses. Since mid-September, Oracle's (Nasdaq: ORCL ) Larry Ellison has been selling a million shares of his stock every day. Microsoft (Nasdaq: MSFT ) co-founder Bill Gates sold 14 million shares in August, and you'll find similar sales in previous quarters. And although Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) Warren Buffett rarely sells shares, he has used them to make large gifts to the Bill & Melinda Gates Foundation, which in turn had a long series of daily sales that ran from July 2009 all the way to February 2010.
In the coming months, insiders have one additional reason to sell: the prospect of higher capital gains tax rates. Until the end of the year, insiders can be assured that no matter how much profit they make, long-term capital gains will be taxed at a maximum rate of 15%. Next year, they'll rise to a maximum of 20% if Congress takes no action, and there's a possibility that high-income taxpayers like corporate executives could see legislation to raise the tax rate even higher.
Watch the election
On the other hand, a lot depends on what happens in November's elections. If Republicans take over all or part of Congress, which took no action earlier this year to address next year's tax rates, then at least a temporary extension of current tax rates becomes more likely. That would take pressure off corporate executives to get shares sold before the end of the year.
For investors, the prospect of capital-gains-linked insider selling has two implications. In the short run, if enough insiders rush to take advantage of lower rates on gains, then collectively, they could push stock prices down significantly. So if you're looking to pick up bargains, especially on stocks with major insider holdings and a history of sales, then waiting may yield you better entry points.
Longer term, though, it's important to realize that if these sales are motivated solely by capital gains considerations, they don't bode ill for the prospects of the stocks involved. Whereas some will look at heavy sales as a sign of an imminent downturn for the market, investors with more foresight will look beyond higher insider sales for signs of the motivation behind them. In many cases, any concern created by these sales could present an excellent long-term profit opportunity.
It's valuable to look at what insiders are doing, but you always have to try to figure out what their motivation is for their purchases and sales. In this case, you don't want to draw the wrong conclusion from possibly much higher insider sales in the coming months.
Just because insiders are selling doesn't mean that every stock will fall. Click here to get the Motley Fool's free report, 5 Stocks the Motley Fool Owns ... and You Should, Too.