The headline is dramatic – “Amazon Founder Sells $671 Million Worth of Stock.” Other headlines pointed out this is the largest stock sale Amazon CEO Jeff Bezos has ever completed. Speculation mounted after the news broke. Is Bezos worried that Amazon can’t make enough money as a company to justify its high stock price? Does this mean Amazon’s stock price has topped?
Although we don’t know exactly what Bezos was thinking, we can be fairly certain he doesn’t believe this is the end of Amazon. While $671 million is a big sale, it represents just 1% of the shares Bezos holds.
Bezos still owns almost 82 million shares of Amazon, about 17% of the company. Last week’s sale was his largest since last August when he sold $534 million worth of stock. You probably noticed a pattern here – Bezos seems to sell a large amount of Amazon stock every August.
That pattern is seen in many companies. Founders tend to have large positions in their companies. For Bezos, that position still amounts to about $55 billion worth of stock. His net worth is estimated at about $66 billion so Amazon represents about 83% of his net worth. If you or I went to a financial adviser with more than 80% of our net wealth in a single investment, the adviser would most likely urge us to sell some of that stock in order to diversify our portfolio. In all likelihood, that is all Bezos doing. The dollar amounts of his sales are worthy of headlines but the decision to sell is simply good financial planning.
Bezos is not alone. Bill Gates regularly sells shares of Microsoft and other CEOs sell in accordance with plans to diversify their wealth.
While Bezos’ decision to sell is insignificant to an analysis of Amazon, a CEO’s decision to sell can be important. If the CEO, or another corporate insider, sells all of their shares in a company, that could be significant. Or, it could just mean the corporate insider is raising cash to buy a home, or a boat or to pay a college tuition bill. It’s difficult to determine exactly what corporate insider selling means.
Their buying is less ambiguous. Corporate insider buying is almost always bullish.
You might be wondering how we know when insiders are buying and selling. Insiders, and large investors, are required by law to tell us exactly when they buy and sell through filings with the Securities and Exchange Commission (SEC).
The rules are very specific. When an individual becomes an insider, which is defined as an officer or director of a company, they must make an initial filing of their holdings on an SEC’s Form 3. This form is required for all insiders before a stock starts trading. For established companies, the form is required of all new officers and directors within ten days after they assume their position.
Changes in ownership are reported on Form 4 and must be reported to the SEC within two business days. That’s how we learned of Bezos’ sale. Form 4 is filed whenever an insider buys or sells stocks, no matter how big or small the transaction is.
For example, from the SEC database, we know that Ernest Waters, a director of York Water Company (Nasdaq: YORW) bought 3 shares of stock on July 15. This transaction was worth about $90 and Mr. Waters seems to buy 3 shares every three months. This transaction is insignificant in many ways, but reveals that members of the company’s board of directors do own small positions in the company. If we saw a purchase of 300 shares one quarter, that could be a bullish signal.
On the other hand, this purchase can be interpreted as a bearish indicator for the company. It costs money to file the forms and legal fees associated with this filing could easily have exceeded the amount of the purchase. Management seems to believe small purchases display bullishness in the company, but an analyst might interpret the small purchases as window dressing and wasteful since the costs of filings are expensive and decrease profits.
So far, we have two examples of insider activity and the only similarity between the transactions is that detailed analysis is required to determine what the activity means. Even after detailed analysis we can’t be sure what the insiders are thinking. This demonstrates a problem with analyzing insider data. Individual transactions have little importance in many cases. It could be better to analyze larger trends in the data.
The study of insider activity dates back to at least the 1960s. Researchers looking at insider buys and sells from 1960 through 1966 found that stocks with large insider buying outperformed the broad market. The logic behind this result still holds up fifty years later.
No one knows a company better than the insiders, which include key officers like the chief executive officer and chief financial officer and members of the board of directors. These insiders can buy and sell shares of the company whenever they’d like to, although there are often policies restricting activity in the week before and after earnings reports. When they choose to buy, it could be because their outlook is especially bullish. Remember, they are buying with their own money and want to avoid losses like any other investor would.
To benefit from the tendency of stocks to outperform when insiders are buying, indexes have been developed that show the intensity of buying and selling. One of these indexes is maintained by Barron’s and is updated weekly. It is shown below with the readings in early August 2016.
This indicator is a ratio of shares sold to shares bought. It was set up that way to generate buy signals when the indicator is at a low value and sell signals are at high values. Notice in the chart how the insider transactions ratio was low in August 2015 and again in January 2016. Major stock market averages were selling off at these times and insiders seemed to be taking advantage of lower prices to accumulate shares of their companies. This is an example of how the indicator can be used.
You don’t need to monitor insider transactions all of the time. After stock market averages sell off by 15% or more, you could check the indicator. If insiders are buying, the probability of a market rebound are high. If they are selling, there could be more declines ahead.
If you follow insider transactions closely, the data can provide insight into which companies to buy. In addition to providing the index shown above, Barron’s also posts a list of companies with significant buying and selling. Companies with heavy insider buying could provide a starting point for analysis but this would be just one data point. You could confirm the buy signal with another indicator like high relative strength in the stock or low fundamental valuations.
Insider selling is less meaningful because, as noted, insiders can sell for reasons related to personal financial planning. However, if a large number of insiders are selling, that could be a red flag indicating potential problems are ahead for the company. Using insider selling to analyze individual companies will require more analysis but could be worth the effort, especially if you are comfortable shorting stocks or using put options to benefit from potential declines.
Insider transactions could be among the most important pieces of data that is ignored by individual investors. It can help you buy during market selloffs and the data can help you identify the most promising companies at any given time.