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Should You Be Buying If Insiders Are Selling?

Ivan Martchev
September 21, 2009

Insiders have been aggressively selling stocks of late. As my Foolish colleague Tim Beyers pointed out earlier this month, research from TrimTabs indicates that the ratio of insider selling to insider buying is running at 30.6:1, which is the highest number since the firm started tracking the data in 2004. In addition, companies have been record net sellers of stock, to the tune of $105.2 billion over the past four months.

Meanwhile, short interest has fallen dramatically, and margin debt has spiked upward. From a sentiment perspective, there are also signs of extreme optimism just as insiders are selling into the rally: 51.6% of advisors surveyed by Investors Intelligence are bullish, the highest level since December 2007.

So, what should you do?
I know from experience that investors get most bullish near the end of a big run, and most desperate near a bottom. The numbers above confirm that. I didn't think that the economic situation was as bad as the market was projecting it to be in March, and I don't think it's as good as the market is discounting it to be right now. Which brings me to point out the obvious: Investors should avoid the low-quality stocks that have run up the most during the rally and focus instead on established companies that can thrive in the current challenging economic environment.

A different kind of insider selling
To be fair, there are situations where insider selling is not necessarily bearish. I recently came upon an exciting specialty lab company, Genoptix (Nasdaq: GXDX  ) , that had seen strong insider selling since going public in 2007. Genoptix is similar to larger rivals Quest Diagnostics (NYSE: DGX  ) and LabCorp (NYSE: LH  ) , but it goes a step further by employing specialized doctors who help oncologists and hematologists analyze test results throughout each patient's course of treatment.

The problem was that Genoptix was still majority-owned by venture capital funds that needed to monetize their investment. So even though the company kept delivering great financial results, the VC funds kept selling shares. There was a secondary offering in February 2008 that represented only insiders that brought the insider ownership from 59% to 48%. Still, the remaining overhang has been pressuring the shares ever since, despite the company's being consistently profitable and beating its earnings estimates every quarter. Genoptix is an example of benign insider selling, in my opinion.

Bullish insiders are like needles in a haystack
Because I was curious, I looked at insider purchases and sales over the past several weeks independently. Doing so confirmed the data from TrimTabs: there's way more selling than buying right now. There is insider selling at Kohl's (NYSE: KSS  ) , probably because of the sorry and deteriorating state of the