INSIDER SELLING NOT THE REAL CONCERN….

Forbes is out with an excellent article on insider selling that comes to a much different conclusion than we did in our article “More on Insider Selling” and “Sold to you!”  Forbes is arguing that insiders are selling because, just like everyone, they loaded up on too much debt during the boom years and now need the cash for liquidity purposes.  They think you should ignore this recent bout of insider selling (and lack of buying) because these are “not traditional times” (read: “it’s different this time).  Forbes is completely off base.

The article suffers from the same fatal flaw that most investors do when they study insider transactions:  they focus too much on the selling.  See, insiders sell for various reasons: the trading window might only open a few times a year so they unload a huge amount of stock all in one block, they might just need some pocket change, they might be interested in distributing stock to investors, they might be getting margin calls, etc.  But insiders only buy for ONE reason: they believe their stock is going up. Forbes misses the point here by focusing too much on the sales.  The thing that is so alarming about the sell:buy ratio is the fact that the buying is non-existent. Insiders are essentially giving a big fat “zero confidence” vote in their own shares.

Forbes goes on to argue that insiders are heavily in debt and in dire need of cash:

Vince Farrell, chief investment officer at Soleil Securities, says that its foolish to assume that insiders are bailing on stocks because they believe they’ve topped out. “I think a lot of corporate biggies are guilty of the same thing as the subprime borrowers–too much debt,” he says.

Farrell pointed to the example of Aubrey McClendon, the founder and chief executive of natural gas firm Chesapeake Energy ( CHK – news – people ). Though already a multi-billionaire in August 2008, McClendon took on major leverage in order to buy more of his firm’s stock, eventually owning more than 32 million shares. But by Oct. 10, 2008 the vast majority of his shares had been sold, as McClendon fell victim to a margin call.

As Forbes notes, McClendon is a unique case.  He received a margin call on his CHK position.  He wasn’t raising cash for personal reasons.  I think it’s important to note that McClendon made an egregious $112.5MM last year – a year in which his stock fell 60%+.  It’s safe to say that McClendon (a billionaire) is not only a unique case, but is doing fine financially – he’s not your average consumer who is losing their job or suffering to get by on a lower/middle class income while caring for a family.  Using McClendon as an example of the financial distress of the average citizen is practically insulting to every hard working person in this world.  In addition, the McClendon selling was 6 months ago.  It’s not exactly relevant to the current environment.  McClendon is a unique case.  None of the insiders I have studied on the sales list appear to be as leveraged to their own stock as McClendon was.

Forbes goes go on to note one instance of insider buying:

Sacha Millstone, senior vice president of the Millstone Evans Group at Raymond James, in turn asked investment advice firm Hays Advisory about whether they thought insider-selling levels were unusually high. They answered back that there was unusually high buying during March’s bottom. Millstone says that, knowing this, it only makes sense that April would see strong selling. As such, she doesn’t see insider selling as any reason to hit the panic button. “We expect some kind of pullback here, but we don’t believe insider activity is indicating anything dire,” she says.

So, they were buying at the bottom and now they’re not buying at all?  As I mentioned before, don’t focus on the insider selling so much as the insider buying.  The lack of buying right now isn’t necessarily a red flag, but it certainly isn’t a big vote of confidence going forward….

Cullen Roche

Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.

He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.