While just one piece of the investing puzzle, insider buying and selling can provide valuable clues when setting up a stocks to watch list.
When looking at individual stocks, there is a general rule of thumb to follow when looking at insider buying and selling. Mutual fund legend Peter Lynch said it best: "There are many reasons why insiders sell, but only one reason insiders buy." That reason being, of course, that insiders know something about their company that they are certain will drive the stock price higher.
Overall, more insider selling than insider buying by corporate officers and directors can be a bearish market indicator. Looking back, a pickup in the pace of insider selling in December was a harbinger of the slump in the markets we've seen so far in 2014.
While the insider selling has slacked off somewhat so far in the New Year, there is still a strong bearish bias to insider activities. According to Barron's, the top 20 incidents of insider selling in recent weeks totaled more than $364 million, while the top 20 incidents of insider buying totaled just $7.5 million.
Cloud-based solutions company Cvent Inc. (NYSE: CVT) saw the most selling recently, with five insiders combining to dispose of more than $90 million worth of stock. Much of this selling was driven by liquidity and diversification issues related to it being an IPO that went public in August.
Meanwhile, the former chief executive officer of VeriFone (NYSE: PAY) disposed of more than $50 million worth of shares over the past few weeks.
Now on to the buyers...
Stocks to Watch: Where Insiders Are Buying in 2014
In most cases, insider buying is a precursor to a higher share price over the next year. According to Nejat Seyhun, a professor and researcher in the field of insider trading at the University of Michigan, whenever you have insider buying, the stock tends to outperform the total market by 8.9% over the next 12 months.
Here are two stocks to watch for a turnaround as insiders load up on shares...
First on our list of stocks with insider buying is American Eagle Outfitters (NYSE: AEO), which has seen the value if its shares cut almost in half in the past year. The problem has been a shift in teen fashion - its target retail market. Both sales and profits are down, and earnings for the December quarter are expected to disappoint.
But Jay Schottenstein, the Chairman of the Board, who recently took the reigns as interim CEO, apparently believes he has what it takes to right the ship. He just spent a little over $6.4 million to buy 500,000 shares of the company. On the same day, a member of the board of directors snapped up 5,000 shares of the troubled retailer.
This next company has seen two recent insider buys and is an affordable way to bet on growth at under $7 a share...
S&W Seed Company (Nasdaq: SANW) is another stock that has seen its price fall over the past year. The company breeds, grows, processes, and sells agricultural commodities.
The company has faced significant challenges over the past year, most notably weather conditions that wiped out as much as 20% of alfalfa seeds in a key growing area in California. S&W also entered the fast-growing market for stevia, the newest sweetener product, but saw most of its crop fail due to the use of the wrong herbicides on the fields.
But S&W management believes this year will be different. In its most recent earnings report, they said "It is the company's expectation that upon the conclusion of the recent and short term market uncertainty, strong demand and pricing should commence throughout the remainder of the fiscal year."
And they're putting their money on this sentiment with their insider buying. One director, Grover Wickensham, just spent $560,000 to buy 100,000 shares of S&W stock. President and CEO Mark Grewal spent more than $90,000 of his money on S&W shares.
Investors should pay close attention when officers and directors use their own cash to buy shares on the open market. Most of them have options grants and other compensation methods that reward them when the stock price rises, so spending their own money indicates a very high degree of conviction in the future of their companies and makes them insider stocks to buy.
Another way to identify stocks to watch for a rise is by following what activist investors are doing. But there is one activist investor in particular that has a track record for getting the most out of the stocks he targets. This man is arguably the most successful activist shareholder of all time...
About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.