By Carmel Fisher, Managing Director
17 March, 2017
What makes the share market interesting is that all share transactions involve buyers and sellers who have their own perception of value.
Sellers sell at what they believe to be a good price; buyers think that same price is a good buying opportunity.
The only time a buyer or seller might have an information advantage is if he or she is an insider.
The term insider is generally associated with the illegal kind of insider trading where someone inside a company trades based on non-public information that can have an impact on the company's share price.
But there is a lot of insider trading that is absolutely legal — essentially the buying and selling transactions of executives, key employees, major shareholders and directors of a company who, because of their position, have access to the most up-to-date information about the state of a business.
Stock exchange rules demand that insiders disclose details of their trading, within days of each trade. There's an entire industry devoted to monitoring the trading activities of insiders, in the belief that, when insiders buy or sell, they send a signal to be heeded.
A recent University of Michigan study found that, when executives bought shares in their own companies, the stocks tended to outperform the total market by 8.9 per cent over the next 12 months. Conversely, when they sold shares, the stock underperformed by 5.4 per cent on average.
Some recent Australian examples give credence to the Michigan study. One Australian fund manager described 2016 as a "banner year for insiders" of Australian listed companies.
He cited six of Australia's worst-performing companies losing $A11 billion in value in the six months to December 2016. Well-timed sales by insiders helped them avoid the share falls that followed profit warnings and downgrades.
"In total, nine executives and directors sold shares in Aconex, Sirtex Medical, Bellamy's Asutralia, Vocus Group, Healthscope and Brambles worth about $A60 million since August. These shares would now be worth just $A32m."
He noted "a consistently under-appreciated source of intelligence as to the future prospects for an individual company is trading in that company by insiders."
Judging from the reaction to the sale of $A27 million of Ramsay Healthcare shares last week by retiring CEO Chris Rex, other investors agree.
Rex is retiring from his role after 22 years with the company and is arguably justified in "taking some of his wealth off the table". He has retained more than $A50m of shares in the company so presumably doesn't view its prospects negatively.
Nevertheless, some investors interpreted his share sale as a negative signal and the Ramsay share price closed 2.5 per cent lower on the day the sale was announced.
While I understand the logic around insider selling, I don't believe it is a rule that should be applied universally.
There can be legitimate reasons for an insider to sell — divorce, estate planning or meeting tax liabilities. An insider might have the bulk of their wealth tied up one company; it is perfectly reasonable to want to diversify one's assets.
I would argue that insider buying activity is the really useful signal.
Legendary investor Peter Lynch said: "Insiders might sell their shares for any number of reasons but they buy them for only one: they think the price will rise."
If we assume insiders will always know more than us, the time to follow their lead is when they put their money where their mouths are and buy more shares in their business.