Is Insider Selling a Red Flag?

When insiders at a company (typically top management) buy or sell shares of the firm's stock, people tend to pay attention. After all, these folks probably know the company better than anyone else. But if an insider is selling shares, it's not necessarily a problem.

Imagine that you're a shareholder in Carrier Pigeon Communications (ticker: SQAWK) and their CEO, Frederick Shmedrick, has filed to sell 20,000 of his shares of company stock. This is insider selling. Does it mean that Carrier Pigeon is in trouble? Does Fred know something the rest of us don't know? Should we all sell our shares of SQAWK?

Many investors might worry about this, thinking that it's a bad sign. But the truth is that insider selling isn't necessarily something to fret about. Let's think about why Fred might be selling.

Maybe he really does think the company is in trouble. Or maybe he believes another investment holds better promise. Or possibly he just needs the money -- to buy a house, to pay for his kid's college education, or to bid at Sotheby's (NYSE: BID  ) for Theodore Roosevelt's gilded ashtray.

Another reason many executives sell their shares is that stock options are the major component of their compensation package. This is particularly true at upstart technology companies. Some of these managers have worked for the company for a long time and have been fed stock options by the board of directors instead of big salaries. In many cases, they have most of their wealth tied up in stock, without much moolah lying around. For them, cashing in some options is a fairly routine thing to do.

Executives sell for a variety of reasons. If you see an insider selling shares, it doesn't necessarily mean the company is in trouble. (Of course, if you see droves of insiders selling, that's a bit more worrisome.) There's always a chance that the insider does know some bad news, but it's just as likely that he simply needed some cash. You should definitely take a look at how many shares he is selling relative to his total ownership position. Insider-sale reports should include that statistic -- if they don't, consider calling the company and asking for that information.

Insider buying is a much better sign. After all, managers don't buy shares of stock unless they're believers. But, next time someone shouts that insiders are selling a stock you own, don't jump ship without doing a little research first.


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