Another Reason to Buy Insider-Owned Stocks

Investing in companies whose leaders own a lot of company stock can give you a big edge. Over the past two months, you've seen another big reason that riding the coattails of executives, directors, and other corporate insiders can put more money in your pocket over the long run.

Below, I'll reveal the lesson that insiders have taught their shareholders in November and December. But first, let's take a step back and explain why looking for high insider ownership is such a smart move when picking a stock.

Why you should go with insiders
The idea behind investing in companies with high insider ownership is simple. If managers are shareholders, they're more likely to take actions that are in shareholders' best interests. That's a big part of why so many corporate boards have given executives equity-based incentives like restricted stock or stock options.

Of course, just having a CEO own a bunch of stock doesn't necessarily lead to good results. Options can create the wrong sort of incentives for corporate leaders, as their one-sided nature doesn't match up with the risks that shareholders have to face. Options disproportionately reward stock price increases without forcing leaders to suffer the consequences of share-price declines, encouraging risky gambles that maximize potential gains without having to consider the impact of losses. Even outright stock grants don't always give managers and other insiders the connection with the company that investors would prefer to see.

What's more important is the attitude insiders have toward their shares. With many founder/CEOs, that shareholder-focused attitude is clearly present, as founders wrap their entire lives into their companies and make it part of their personal mission for them to succeed.

Insider ownership can lead to huge gains for long-term shareholders who choose to share in the victories that their insider-leaders earn for them. But recently, we've seen another way in which insiders with big stock positions can drive positive results for their fellow shareholders.

The latest benefit for insider-led stocks
During the last two months of 2012, investors learned another way in which insiders can drive shareholder-friendly policies. As the fiscal cliff loomed ever closer, many companies foresaw the likelihood that tax rates on dividends would rise, with the worst-case scenario involving a near-tripling of the maximum dividend tax rate.

In order to lock in the low 15% maximum tax rate on dividends for 2012, hundreds of companies declared special dividends, with The Wall Street Journal pointing to 483 companies paying special dividends in December alone. Yet according to separate research from Markit, more than 40% of special-dividend payers in the fourth quarter had insider ownership of at least 20%, with Las Vegas Sands (NYSE: LVS  ) and Dillard's (NYSE: DDS  ) among the higher-profile companies with substantial insider ownership making special dividend payments. As a Barron's blog post reported, Markit calculated that $8.8 billion of the nearly $31 billion in special dividends paid out during the fourth quarter of 2012 went to corporate insiders.

Insider-led companies were also among those accelerating dividends from January into December to beat the tax-rate deadline. Oracle (NYSE: ORCL  ) actually pulled its January, April, and July 2013 payments into last month's quarterly payout, while Wal-Mart (NYSE: WMT  ) and True Religion (NASDAQ: TRLG  ) contented themselves with accelerating a single quarter's payment.

Get paid
Because interest rates on bonds and other fixed-income securities have been so low for such a long time, the income that stocks pay out in dividends represents a key attribute of stock ownership these days. The latest fiscal-cliff-prompted special dividend moves from insider-led companies provide yet another example of the benefits that investors get when they find well-qualified corporate leaders who have the same desire to produce long-term stock price appreciation that shareholders have.

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Comments from our Foolish Readers

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  • Report this Comment On January 04, 2013, at 12:22 PM, JF125780 wrote:

    Very good article Dan, I've always looked to see how many shares the insiders own in a company and the personal wealth of top management.

    When I bought LVS at the inception in November of 2004 Sheldon Adelson was the 3rd richest man in the United States and owned 89% of the company.

    When the melt down came in 2008-09, he had to save LVS with a loan in which he paid himself back in November of 2011.

    His family now owns 51.5% of the company and with the insiders they own 70.88% altogether.

    He's not the 3rd richest man in the country anymore, but he's in the top 20.

    What a great investment LVS will be over the years.

    Danny Kowkabany

  • Report this Comment On January 05, 2013, at 8:42 PM, crca99 wrote:

    Please say more about the downside of options as related to insider ownership.

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