Is Insider Selling a Good Reason to Dump a Stock?

As a long-term investor, there are only a few reasons you will normally sell a stock. An obvious reason to consider selling is if your overall investing thesis about the company has changed since the time you bought it and you no longer believe in the long-term potential of the business. But, should insider selling also cause investors pause about the long-term investability of a stock?

In this segment of Backstage Pass, recorded on Jan. 19, Fool contributors Rachel Warren and Danny Vena discuss some recent events with Peloton (PTON 2.62%) which recently announced widespread layoffs and a CEO change, and whether insider selling should be a red flag for investors. 

Rachel Warren: Peloton. We were just talking about it a little bit ago. Peloton is in the news again. The company has had its fair share of tough headlines in recent months.

The stock was a favored pick of investors in the earlier days of the pandemic, but the stock has since fallen nearly 80% from its pandemic high. Today, CNBC reported that Peloton insiders sold nearly $500 million in stock before shares plunged.

In a separate report by CNBC, they said the company was partnering with McKinsey to review its cost structure, which could potentially involve cutting jobs, closing some stores. The signs that Peloton is facing serious headwinds to its business, they have been accumulating in recent months. Revenue subscription growth understandably isn't close to where it was in the earlier days of the pandemic.

Peloton set a hiring freeze in place for a few months now. One thing that stuck out to me that I mentioned earlier in this article, CNBC was saying Peloton is going to start essentially tacking on hundreds of dollars in fees for delivery and assembly of its bike and tread products.

The reason for this is ongoing supply chain disruptions, costs, and inflation. For example, the bike will go from, I guess its previous price was, $1,745 from $1,445, so that'll be a $300 increase. Feel free to share any thoughts you have specific to Peloton if this is a stock you follow.

But there's a few broader questions to discuss here. Do red flags go up for you when you see the company insiders are offloading a stock? Would that make you reconsider your position?

Then there's this issue of ongoing supply chain disruptions. Are you worried that these disruptions could keep impacting companies throughout 2022? Danny, why don't you take this one first?

Danny Vena: I'll start with the one that I have the most experience with and that is, when I see insiders selling, it usually means nothing. Now, generally, if it's a company that I follow closely, I will go to EDGAR, which is the Securities and Exchange Commission website. I will pull up the most recent proxy statement, look and see how many shares these particular insiders owned at the time of the proxy statement, and then see what this sale represents of their total.

Most of the time, more than 90% of the time, those sales are inconsequential. The timing usually has something to do with either a big expenditure they have coming up or in most cases, having to do with selling stocks so that they can settle their upcoming federal and state tax obligations.

Happens all the time. But investors see insider selling and their mind immediately goes to, they know something I don't, they're selling, I should sell now, which in the majority of cases is the wrong way to go about it.

Now, I will say I bought a starter position in Peloton during the pandemic because I wanted to see whether or not this trend of exercising in the home is something that's going to stick. I don't believe that it is, which is why it's only a starter position, but I'm willing to be proved wrong. We've seen this boom and bust cycle in home exercise before.

I don't know for sure that it's going to play out the way it has in the past, but I think it will. As far as the continuing logistics issues, yeah, I could easily see that hanging around for months or another year.

Not something that we want to see. But remember, for those of us who follow the Fool philosophy, we're playing the long game. I'm looking three to five years out and how my stocks are going to be doing and not whether or not they take a dip because of a market correction or because of supply chain issues that will last several months or a couple of years.

Warren: No, I agree. It's like, we look with a long-term perspective and it can be a little more difficult sometimes to maintain that perspective during tough market days, weeks, or months.

But it doesn't change the underlying value of that philosophy and it's much, much harder to try to guess what the market is going to do next. Great thoughts from you Danny.