6 am 15 September 2020
Follow the smart money?
Insider trading is where an individual trades in securities when in possession of non-public, price sensitive information, and is unequivocally illegal.
However, insiders, including company directors, are allowed to trade in the shares of their companies so long as they do not posses any undisclosed information. This happens during specified “trading windows” after the release of annual and interim profit reports, when the public has presumably been informed of all material issues relating to the business.
Despite the prohibitions against trading on any material information not known to the public, investors will rightly question what it means when an insider transacts in shares. For example, why has a director who should know the company better than any outsider could, decided to sell down a large portion of their shareholding? What do they really think about the outlook for the company?
This report lists some of the big insider transactions around the August results season. But first, does the academic research support the intuition that you should follow what the insiders do?
What the research says
The academic literature is broadly supportive of the idea that insider transactions carry useful information for investors. A quick review of four papers using data sets from the ASX spanning periods from 1996 to 2015 shows consistent positive excess returns from insider transactions, with three of the reports being statistically significant. The median excess return generated by insiders is 4.3% (Berkman et al., 2016).
This is replicated in studies of offshore markets, with most finding statistically significant positive returns. Within these studies, insider selling has a more pronounced effect than insider buying.
It isn’t always the directors getting the jump on price sensitive news either. A recent study showed evidence of contrarian trading by directors, where sales were made following good news when the price was high, and purchases were made after bad news when the price was low, a strategy that enabled them to generate excess returns (Katselas, 2019).
So, who was trading this reporting season?
The following table highlights some of the more interesting insider transactions during the latest reporting season, but it is not an exhaustive list. It includes transactions greater than $1 million that were actual cash purchases or sales, and includes some selling by strategic holders as well.
Source: Company releases, The Super Investor
There is a very clear skew towards selling by a ratio of almost 9 to 1. A number of founders, directors and strategic holders have used the open trading window to sell material amounts of shares.
Some of the more interesting sale transactions include:
1. Material founder selling in Netwealth, Kogan, Pushpay, Temple & Webster, Wisetech and Xero.
2. Early backers exiting or reducing in Bisalloy, Nitro and Whispir.
3. CEO selling in Cleanaway, Woodside and Baby Bunting.
Reasons for the insider selling were rarely given. A number of the founder sell downs were part of an ongoing program by individuals to diversify their holdings. Some transactions were genuinely uncontroversial and aren’t listed here (e.g. donations to a charitable foundation, funding tax obligations from option exercises, etc). Others raise eyebrows, especially CEO sales where no reason is given.
The level of material buying was far smaller, although many directors did purchase token amounts (often less than $10,000) post result releases. Insiders in Flexigroup were supportive of the large raising conducted during the period, tipping in a combined $15 million, and the Chairs of Cleanteq and Polynovo topped up existing holdings by $3 million and $1 million respectively.
Academic research backs up what most people’s intuition tells them; on average, insiders possess better information and they use it to trade profitably. This information should by no means be the sole determinate of buying or selling a stock. But insider selling in particular should be a red flag if there are other concerns.
The large amount of director selling on this list, particularly in stocks that have exhibited very strong price performance in recent months, should be taken into consideration by investors when making individual stock decisions. It is worth reflecting what this might say about the views of insiders regarding current valuations in the tech sector, where most of the selling has been concentrated.
Disclosure: The author holds shares in A2M.
Berkman, Henk & Bradrania, Reza & Viljoen, Tina & Westerholm, P. Joakim (2016). Insiders’ Profits in the Australian Equities Market. Centre for International Finance and Regulation.
Katselas, Dean (2019). Strategic insider trading around earnings announcements in Australia. Accounting & Finance.
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