Stock-Dumping Insiders Shouldn't Scare You

Just because regular investors sell stocks doesn't mean you should. But when people who know the ins and outs of the companies they work for decide to bail out, then it's another story -- and you should pay attention.

With all the uncertainty in the market lately, it shouldn't come as a big surprise that some investors have been taking profits after a long rally. According to a recent MarketWatch report, though, insiders are ramping up their sales of company shares to one of the highest levels on record.

Loss of confidence
Investors pay attention to insider buying and selling because insiders have more information about the companies they work for than average investors do. As the logic goes, if insiders buy shares, they obviously believe share prices will rise, and so it makes sense to follow on their coattails. Likewise, when insiders sell, they presumably think that they're getting a reasonable or high price for their shares -- and that potential future challenges might push those share prices lower in the near future.

Typically, you'll see more insiders selling than buying. Many executives get paid in shares of stock or in stock options, so in order to supplement their regular paychecks, they need to sell off shares periodically. Moreover, if you already get a big piece of your compensation in stock, you don't have as much incentive to buy additional shares -- just holding onto the ones you get is itself a sign of confidence. Because of this, insider selling is a somewhat ambiguous signal. If executives need cash, they might sell even if they think the stock will go higher.

But recently, insider selling has reached extremely high levels. According to Argus Research, insiders sold more than six times as many shares as they bought last week. When you look only at New York Stock Exchange and American Stock Exchange-listed stocks, that number rises to more than 13 times as many sales as purchases. That's the highest level that the research company has ever seen in 37 years of looking at insider transactions.

Who's doing the selling?
Out of curiosity, I decided to take a closer look at companies that had at least five separate insider sales transactions in the past month. Looking solely at open-market sales, my hope was that a trend would identify particular types of stocks or certain industries that were especially susceptible to insider selling right now.

Instead, I found a diverse set of companies. In particular:

  • Plenty of well-known large-cap stocks made the list, including IBM (NYSE: IBM  ) , Mastercard (NYSE: MA  ) , and Paychex (Nasdaq: PAYX  ) .
  • But several tinier companies also saw big sales. Alexion Pharmaceuticals (Nasdaq: ALXN  ) , which has seen big gains in the wake of strength in sales of its hematology drug Soliris, had 10 separate open-market sales. Similarly, Sun Hydraulics (Nasdaq: SNHY  ) had a strong quarter and boosted its dividend, which perhaps prompted eight sales transactions in the past month.
  • No clear industry trend was apparent. From tech stocks like IBM and Level 3 Communications (Nasdaq: LVLT  ) to consumer-oriented stocks like LeapFrog and AutoZone (NYSE: AZO  ) , insiders in many types of companies found the time ripe to sell.

What should you do?
It can be unnerving to see an insider sell shares of a stock you own. After doing research and concluding that a company has good prospects, you may think an insider sale should lead you to second-guess yourself.

That's usually a bad idea. Sure, some insider selling legitimately results from concerns about a company that turn out to happen. But with so many other good reasons for insiders to sell shares, you risk scaring yourself out of a position if you reflexively hit the sell button whenever you see a company executive bail out.

What you shouldn't do, though, is ignore insider selling entirely. The right compromise is to let insider selling lead you to take a closer look at a stock. Just don't automatically dismiss the reasons that made you buy the stock in the first place. If they're still valid, hang on with confidence -- and know that you may well end up doing better than that executive who sold.

Here at the Motley Fool, we prefer to use insider buying as a signal of coming good times for a stock. Get five strong stock ideas that the Fool owns in its own portfolio; read this free special report and improve your chances of finding a real winner.

Fool contributor Dan Caplinger faces his fear and invests anyway. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of International Business Machines. Motley Fool newsletter services have recommended buying shares of Sun Hydraulics and Paychex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy loves Halloween but still won't scare you.


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