Insider Information You Can't Afford to Ignore

The most important business lesson I (Austin) ever learned I heard in a bar -- but it had nothing to do with taking advantage of the two-for-one happy hour.

You see, I worked at the bar, and it was always packed, thanks to some amazing food cranked out by a feisty little Southerner we called Jimmy Jazz.

Now, ol' Jazz had a couple of other passions besides cooking -- and they all involved taking advantage of two-for-one happy hours. So, when the owner decided to open another bar, he had one major obstacle to overcome.

Some suggested the owner scare Jazz straight. Others suggested he bribe him. But in the end, he didn't give his star chef an ultimatum, a pay raise -- or even any money at all. Instead, he offered him a partial ownership stake in the new business.

Three years sober!
The food is better than ever, too. In business, the best way to ensure your "star players" really perform for you is to make sure that their interests are 100% aligned with yours.

That's why insider ownership should be a top concern anytime you consider buying a stock. After all, if the people running the business don't own a share of it, what incentive do they have to make decisions that are in your best interest?

Last year, management debacles at firms like AIG (NYSE:AIG), Chesapeake Energy (NYSE:CHK), and Merrill Lynch have proved that multimillion-dollar compensation packages, fleets of private jets, and offices decked out with $87,000 Oriental rugs simply aren't enough to ensure that top brass will do what's best for shareholders.

Here's something else to consider ... stock option grants are not the same as inside ownership. They're dilutive to existing shareholders and carry zero downside risk to the option holder. Worse yet, if the stock tanks, shareholders lose real money -- but management's options will simply expire, at no cost to them.

The only insider information you'll ever need
Motley Fool co-founder Tom Gardner ventures to say that insider ownership may be the single most important factor in determining whether a stock is a long-run winner or loser. In fact, at a recent Fool member event, he told the audience:

If you forced me to shield myself from all but one factor, and invest my capital according to that criterion for the rest of my life, I wouldn't look for growth. I wouldn't look for a great balance sheet. I'd focus only on insider ownership.

So my Foolish colleague Matt and I recently sat down and did just that. If you'd like to follow along on your own, simply follow these steps:

• Go to your favorite financial website (Motley Fool CAPS, for instance).
• Enter the company's ticker.
• Find the "SEC Filings" section.
• Look for the most recent proxy statement -- also known as Form 14(a).

Typically, this form will include a table showing the percentages of stock owned by the CEO, CFO, directors, and other top executives. You can also find updated information about insider transactions, including shares bought or sold and the latest accounts of an executive's holdings, on a company's Form 4 filings.

After running our screen, here's a list of companies we came up with that have significant insider ownership, plus have strong revenue and net income growth over the past five years, and high returns on equity -- all factors we think make for a compelling investment opportunity:

*Five-year Compound Annual Growth Rate (CAGR). All data provided by Capital IQ, a division of Standard & Poor's.

Granted, we aren't recommending that you buy any of these companies without doing proper due diligence. But we are suggesting that, given these characteristics -- specifically their significant levels of insider ownership -- each deserves your consideration. Here's why we're so convinced.

So far, way good
Since 2002, Tom Gardner, his brother, David, and their entire Motley Fool Stock Advisor team have dedicated themselves to finding great businesses where insiders own meaningful stakes. Granted, they've also recommended businesses where insiders don't own significant stakes, but their biggest winners speak for themselves:

In fact, of the 10 top-performing picks on the Stock Advisor scorecard -- which are up an average of 492% -- only two had less than 5% insider ownership when they were selected, while six had double-digit percentages.

Of course, that's not the only reason these businesses have performed so well over the past few years. But as you can see, finding management that isn't afraid to eat its own cooking (just like ol' Jazz!) and will dedicate itself to building shareholder value over the long term can lead you to some fantastic wealth-building opportunities.

Now it's your turn
In addition to the stocks we mentioned above, we'd love to hear which companies you think are compelling investment opportunities right now, and why. Simply use the comment function below to chime in.

And if you'd like to see which stocks Matt and the rest of the Stock Advisor team are officially recommending -- including their top two picks for new investment money -- we invite you to try Stock Advisor absolutely free for 30 days.

To learn more about this free 30-day trial, simply click here. There is no obligation to subscribe.

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This article was originally published May 2, 2009. It has been updated.

Matthew Argersinger and Austin Edwards both love a good two-for-one happy hour -- especially when the other is paying. Neither owns shares of any stock mentioned. Marvel, Activision, and Quality Systems are Motley Fool Stock Advisor recommendations. Chesapeake Energy is an Inside Value choice. The Motley Fool owns shares of Chesapeake Energy. The Motley Fool has a disclosure policy.