By John Waggoner
Suppose you called Harry's Electric Service and Harry arrived, his hair standing on end and smoke pouring from his ears. You'd probably be reluctant to be one of Harry's partners.
You can tell a lot about a company by the way management behaves.
Similarly, you can tell a great deal about a stock - or a mutual fund - by how management treats it. It's good to know that corporate executives or fund managers are investing alongside you.
But finding useful information on insider activity can be hard.
Corporate insiders - CEOs, executives and others privy to company information - are free to buy and sell the stock of their own companies, but they have significant restrictions.
An insider can't buy or sell his company's stock based on material information that's not available to the general public.
Consider Sam Waksal, former CEO of ImClone, a biotech company. On hearing that ImClone's new wonder drug, Erbitux, would not get Food and Drug Administration approval, he tried to dump some of his stock. He also tipped off his family.
The Securities and Exchange Commission was not amused. Waksal pleaded guilty to illegal inside trading and was sentenced to 87 months in jail.
Insiders can buy or sell shares of their companies legally if they file their transactions with the Securities and Exchange Commission. You can get important information from those filings - sometimes.
Selling. A great deal of insider selling is a moderately interesting indicator when you're evaluating a stock. But there are many reasons for insiders to sell company stock: taxes, tuition, that starter castle in the Loire Valley. Insider selling alone isn't reason for you to sell.
You should be concerned if insiders are shoveling stock out the window while the stock is plunging, says Chuck Carlson, an editor of newsletter "Dow Theory Forecasts." This indicates that insiders could be bailing out before the stock goes even lower.
Buying. "The age-old wisdom is that insider buying is vastly more significant than selling," says Norman Fosback, editor of the "Insider Trading Guide" at InsiderTradingGuide.com.
Not all insider trading is equal. Companies, especially technology companies, dole out stock options to executives as part of their compensation. The executives routinely exercise those options. They may or may not be bullish on the stock when they do so.
The best type of insider buying is when an executive buys stock in his own company on the open market. You only do that if you really like the stock. Unfortunately, the form that insiders use to report their trades doesn't identify open-market trades anymore. That stopped about a year ago, Fosback says. The SEC still breaks out option sales, however.
You have to use some judgment when looking at insider buying. One large stock buy by a single insider could be part of a compensation package.
But a pattern of repeated buying by several insiders is a good sign, Fosback says.
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