Thinking Big About Small Companies

The Hidden Signal that Insider Buying Sends

February 4th, 2015 | Posted by Torin in Investing | Uncategorized

Everybody knows insider buying has positive signaling properties. Executives own gobs of their companies’ stock through options grants, so just about the only reason for an executive to use after-tax salary dollars to buy even more company stock is because he or she believes the stock will go up.

The executive could think this for any number of reasons: maybe the stock is cheap; maybe favorable business developments are around the corner; maybe would-be acquirers are sniffing around the industry. It doesn’t matter. The essential fact is that the executive is publicly predicting a higher stock price with his or her bank account. Rocket science this is not.

Consequently, investors pay close attention to insider buying. Some investors use the daily register of executive stock purchases as a hunting ground for new investments. Some use executive purchases as another box to tick when they run their screens. Some use computer programs that simply buy when an executive buys.

Some funds take it even further. I know at least one investment manager that maintains a database of past insider transactions so that it can assess which insiders have proven to be especially shrewd purchasers of their own stock (and, conversely, which ones have been poor at it).

This is all well and good, and I concur one hundred percent with every bit of it.

But I think there is an even more important signal that insider buying sends:

Insider buying indicates a company is run by executives who think like owners, not employees.

To me this is of the utmost importance.

You don’t need to look at many institutions to see that an ‘employee mindset’ prevails in virtually every large organization. The employee mindset can be about many things: a promotion; more responsibility; a bigger salary; more vacation time; better hours; a nicer office; improved placement in the office hierarchy; a more desirable region to cover; a bigger expense account; etc. My point is not that the average corporate employee does not work hard, but rather that different employees have vastly different motivations.

For an investor there can be but one motivation: a long-term increase in the company’s intrinsic value per share.

This is why most Monte Sol investments have significant recent insider buying, high insider ownership, or both. Because insider buying tells me that the executives and I share the same motivation. A motivated person is a powerful person. It should come as no surprise that companies run by people who are predominantly motivated by the company’s per-share value tend do well in share price performance.

Plain and simple, a CEO who buys a big chunk of his or her company’s stock in the open market or takes base compensation in stock isn’t trying to get a better salary or secure a longer term of employment. No, that executive is investing in his or her own company to earn an attractive return on capital. Just like I am.

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