Is Insider Selling a Bad Thing?

If a CEO or other key player at a company you invest in sells some of their shares, is it a cause for worry? The short answer is "maybe, but maybe not." In this Fool Live video clip, recorded on March 29, Fool.com contributor Matt Frankel, CFP, and Industry Focus host Jason Moser talk about some of the common reasons why insiders sell stock, and why it isn't necessarily a cause for concern. 

Jason Moser: Matt, before we wrap the show up, we have a question from a listener on Twitter (NYSE: TWTR) I thought we could tackle here real quickly. @Lee in Raleigh asks, hi Jason, long time Motley Fool subscriber podcast listener. Thank you, Lee, appreciate that. I know you're big on McCormick (MKC 0.59%), yes, I'm and was wondering if you could explain on an upcoming show what's up with the statement of changes in beneficial ownership of securities that are currently pending. I saw it when I got the proxy statement. Thanks for the question, we really appreciate it. Matt, I think her question hits really in two ways. In one, she uses McCormick as a specific example, she had a link to the investor relations page, and there were all these Form 4s there, these SEC filings that are required whenever insiders purchase or whenever they transact shares in the company. I think on one, she's asking specific to McCormick is there something to be concerned with and then two, ultimately what to make of insider selling in general. I think it's a good question for a number of different reasons and I thought it'd be one we can talk about for a minute here because I think it's easy for folks to see insider selling and immediately, whoa, think something is up, that's a problem, that's a red flag. That's not really often the case though, is it?

Matt Frankel: No. First of all, those statements of beneficial ownership changes, can be for or against a lot of them are purchases. I'll let you speak about McCormick's specifically, I know that's top of your watch list. In the pandemic, especially I saw a lot of my favorite company's executives are buying hand over fist. STORE Capital (STOR) is an example where pretty much every executive bought shares when the pandemic started. Ryman Hospitality (RHP -1.70%) is another one where the CEO put millions of dollars of his own money into the stock at low prices. They work both ways. That's the first one. Number two, there are a lot of reasons CEOs and other insiders, those are usually a company officer or a board member. When you see a change in ownership. A lot of them get compensated with stock options. That's a big part of their compensation or restricted shares that can't be sold for a certain amount of time. When those mature, a lot of times they will exercise then immediately sell them. Not necessarily because they don't believe in the company, because that's a part of their salary. Let's say I give Jason restricted stock options, in two years, he could sell them. That makes it in his best interest to make the company perform really, really well over those two years. Then at the end of those two years, though, he can exercise those options as part of his compensation. Doesn't mean he doesn't believe in the company. Usually, these people have other, each year this cycle repeats, they get more restricted stock and more options and incentivizes them to keep doing that. Jack Dorsey is one of big one that you'll see them from time-to-time like there'll be stock options that expiring he'll need to sell them. Obviously still believes in his companies, he's working pretty much for free, but it's a form of compensation. The Form 4s should tell you there's usually a code with the transaction that says if it was an open market sale, whether it was options are exercised, whether they actually disposed of shares from their own portfolio, things like that. I would say, to make a long story short, it depends on the circumstances surrounding the sale and whether or not the person is still incentivized to do their job well. Obviously, if an executive dumps 50% of their shares with no explanation, it should raise some eyebrows.

Moser: Yeah.

Frankel: But if they're exercising restricted shares and selling them and still own two or three percent of the company, then I wouldn't look too much into it.

Moser: I mean, either I think you really nailed most of that there. I don't think there's anything really different in play with McCormick here. A lot of these Form 4s are related to restricted stock units, it is a compensation thing. I take a perfect example I tell folks sometimes listening to me, this is The Motley Fool. The Motley Fool is not a publicly traded company, but we as employees do get shares in the company. I've sold shares in The Motley Fool before, and that's not to say that I don't believe in our accompany far from it. I absolutely don't believe in the company, but it's a part of compensation. It goes back to that old saw from Peter Lynch who said paraphrasing, but there are many reasons to sell and one reason to buy. Everybody is a little bit different. They've got things going on in their lives, this is compensation-related, people plan for projects at home or education, or expenses, whatever it may be. It's also worth noting too, oftentimes you'll see these sales oftentimes are related to a specific rule, rule 10b5-1, which ultimately its an SEC plan which allows the insiders, the publicly traded companies to set up a trading plan to make those sales without creating the impression that they're trying to time them. I think generally speaking, looking for companies where there is strong insider ownership is a great thing to find its not a reason to invest, it's a nice thing to find. The bigger the company, the more difficult it's going to be for insiders to hold a meaningful amount of those shares just because the company is bigger and McCormick has been around for a long time. But yeah, looking through the Form 4s and McCormick is certainly not the only company where you see this. It looks like in most cases these are restricted stock units where sales are happening and that's because their performance compensation. Then you can also see on those Form 4s, the number of shares held by that individual after the sale and I can give you an idea of what exposure they still have to the business but yeah. I don't see anything here in regard to McCormick's Form 4s they're creating concern for me but it's always something worth noting. It is, I think the knee-jerk reaction is insiders are selling, there must be something wrong. But it's something that requires a little bit more digging into and I think understanding that again, like Peter Lynch said," There a lot of different reasons to sell." You can't really hold them against people because in most cases it's compensation-related and we all have our plans.