Should You Follow The Insiders?

When deciding to buy or sell stock, should you follow the insiders?

I have heard the term “follow the insiders” used in two contexts: following their transactions (buying or selling) or following their job moves (i.e. leave the stock when they leave the company).

Photo by tanakawho, courtesy of flickr

Today, I’ll examine following the transactions of the insiders. The logic is pretty basic. If insiders are buying shares of the company, then they believe the stock is undervalued. Perhaps there is something positive in the pipeline.

If insiders are selling shares of the company, then they believe the stock is overvalued and want to take their profits.

Makes sense, right? After all, who would know better than an insider? It makes sense, but it doesn’t always work.

I came across an article from May 2008, “Follow Berkshire Hathaway and Invest in the Financial Sector,” about following the insiders.

The article noted that insiders were buying financials, particularly the stocks listed below:

Wachovia Bank (WB)
Fifth Third Bank (FITB)
American Express (AXP)
Genworth Financial (GNW)
Colonial National Bank (CNB)

The article went on to say that the moves of insiders are not usually confirmed in the market for 6-9 months, and many people who follow the insiders lack patience and end up selling before the confirmation.

Well, it’s been 14 months and anyone who followed any of these insider instincts is in losing territory.

Wachovia is no more. Fifth Third has lost two-thirds of its value. American Express is down over 40 percent. Genworth has lost over 70 percent and Colonial, now a penny-stock, has lost 90 percent of its value.

This may be an example using a small sample of stocks over a short period of time, but it proves that no tool, no matter how seemingly sensible, always works. These could be good companies that have been severely punished or bad companies that were grossly overalued and due for a decline. Either way, the bottom line is a negative one (at least for now).

Just because the logic is there, doesn’t mean the profits will follow!