Inside the Markets: Despite the Insider Buying, I'm Still Selling

Combining my insider data with market technicals is keeping me bearish

March 17, 2008
by Jonathan Moreland

DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.

As many CPA Insider™ readers may know, corporate insiders have been buying shares of their beaten-down companies at a rate not seen in the past five years. That's the good news. The bad news is that I expect my insider buy/sell ratios to get even more positive in coming months as the U.S. equity market continues its larger downtrend.

To be sure, the market can have a very successful two percent to three percent up day at any point. But as the two-week rally in January clearly illustrated, a good string of trading days does not mean that a market bottom has been reached. January's rally failed at the resistance offered by its 50-day moving average. With the credit crisis far from over, odds are high that any future rally attempt will also fail at that same point. Depending on which index you look at, that would mean a five- to seven-percent lid on any upside from present levels.

So I'm still leaning short, despite the large number of beaten-up stocks insiders are obviously seeing value in, given their buying activity. Fortunately, insiders have also proven very useful at pointing me towards stocks that — though well off their highs — likely have further to fall.

As I explained in my last column, the common wisdom about using insider selling data to garner investment intelligence is that it is much more difficult to use than buying data, since insiders have so many legitimate reasons to sell. That insight seems trite, but it is true. Diversifying assets, buying a house, paying for tuition — these are all reasonable excuses, among others, for executives to sell their shares.

The excuse starts to ring false, however, when insiders continue to sell after their stock has crumbled in value. Selling any asset for any reason after it has lost much of its value just doesn't relay much optimism that it is likely to rebound in the near future.

'Shorts' Sighted

I produce a list of weak stocks with significant insider selling every week in my newsletter. It is usually much smaller than the list of firms I publish showing interesting insider buying activity. From 2005 to 2007, it was also not nearly as profitable as the buy-side table for choosing stock picks. That changed last December. My "Short-Sighted" table, as I call it, has recently been my prime fishing ground for profitable investment ideas, and I expect that to remain the case for at least another few months.

Last month I offered up several short ideas that originally stood out from this table. This month, I'm going to present the whole list from the most recent week (see table below).

If Their Own Execs Don't Like Them, Why Should You?
(stocks that are trading poorly and still have insiders selling)

At the very least, you and your clients should stop considering bottom feeding on any of the stocks on this table. With so many hammered stocks having insiders showing faith in them right now, why on earth would you choose to make your stand in this cruddy market with a weak stock that still doesn't impress its own executives?

But I have found that this list is also a great place to start when looking for candidates to short. Last month I suggested shorting Metabolix (NASDAQ: MBLX), LoopNet (NASDAQ: LOOP) and Molex (NASDAQ: MOLX). While they are all down since then, MBLX has been a clear home run. Despite even more weakness over the past month, however, MBLX and MOLX appeared again on my Shorts Sighted list last week.

When I decide which stocks to actually short from the table above, I focus on past growth stock darlings or momentum plays that have obviously broken down. Even after their demises, they are often still very expensive for the still high, but recently lowered growth prospects they are offering. With their rate of growth slowing now or likely to slow in the coming quarter, growth and momentum investors are likely to keep shunning them. Yet they aren't cheap enough for value players to offer their support yet. That's the gap I'm trying to exploit in this lousy market. To that end, so far so good.

Names that I think still have enough downside left to short into include American Public Education (NASDAQ: APEI), RiverBed (NASDAQ: RVBD) and even growth-stock poster child Google (NASDAQ: GOOG).

And while many talking heads on the financial news channels seems to see value in big name tech firms, I can't help but notice the likes of Dell (DELL), Cisco (CSCO) and Intel (INTC) on the above table. Given their low valuations after their recent price declines, I don't view these three tech bellwethers as the most obvious shorts. But the insider selling should certainly be a red flag for any investor thinking about bottom feeding on these names.

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Jonathan Moreland is the Director of Research at New York-based Insider Insights.com.
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