A Scary Time for Stocks?

Most Wednesdays, I'm here to give you my five best stock ideas based on the week's insider buying activity. Not today. Today, there just isn't much to report.

Of course, "not much" isn't the same as "nothing." Insiders at Discover Financial Services (NYSE: DFS  ) spent $360,000 to pad their positions over the past week. CEO David Nelms was responsible for more than $272,000 of that figure.

Nevertheless, by my read of insider tracking tool Form 4 Oracle, most other buying was either:

  • Performed by hedge funds.
  • Performed by penny-stock insiders.

Neither of those things makes for bullish signs.

To be fair, it's possible that I'm being picky. Too often, I read insider buying tips that focus on size --  as if a $20 million purchase by a director is more important than a $20,000 purchase by the CEO. Research says that simply isn't true.

Nejat Seyhun, author of Investment Intelligence From Insider Trading, explained in a 2004 interview with Fool co-founder Tom Gardner that consistent buying at the executive level is most predictive:

What I found was two things: When a CEO trades or a very top executive trades, both the magnitude and the likelihood that the trade is information-related is higher. So, CEOs tend to trade on more important information. And with a greater probability, prices follow the CEO's trade in the same direction. ... I think also, from the popular press, what we notice is if you look at, say, The Wall Street Journal, the types of insider trading they report is based on the number of shares bought or sold. They use that as the No. 1 indicator as opposed to who does the trading. I think that leads to some popular misconceptions. It is very important to know who has made the trade. [Emphasis added.]

Thank you, sir. You've just crystallized my problem. Not enough CEOs of major companies are buying this week.

When they do, as Seyhun says, the results can be dramatic. Notable examples include Aubrey McClendon of Chesapeake Energy (NYSE: CHK  ) and Kosta Kartsotis of  Fossil (Nasdaq: FOSL  ) . Both have enjoyed market-crushing gains with their purchases.

Others have yet to cash in as big. But I'm optimistic that bets made by P.F. Chang's (Nasdaq: PFCB  ) CEO Richard Federico, American Capital Strategies (Nasdaq: ACAS  ) CEO Malon Wilkus, and the entire executive team of nanotech investor Harris & Harris Group (Nasdaq: TINY  ) will pay off in the years ahead.

So, to recap, when evaluating insider buying:

  • Follow the CEOs. They've got better information than most insiders do, and, consequently, their buys and sells frequently presage market movements.
  • Grade bulk buys over big buys. Popular wisdom says that a multibillion-dollar buy by a hedge fund manager who also happens to be a board member is more valuable than a $20,000 purchase by a sales VP. Wrong. Executives are closer to the mechanisms that produce the profits and cash flow that we investors crave.

There's your update. See you back here next week, when we dig through more insider filings in search of the next home run stock.

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