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May 042012
 

Insider trading Nelson? But that’s illegal. Sure, I’m badass, but I’m not that far badass. Besides, I’m too pretty for prison, even if it’s wuss white-collar prison.

No, stupid. Not that kind of insider trading. Let me explain.

There are essentially two types of insider trading. Firstly, let me explain the bad version. A few times a year, usually right before a company releases quarterly earnings, there will be a period of time when management and board members of this company will know how earnings are going to be. This information can be used to either buy or sell shares, which would let insiders profit on information that isn’t widely available.

This gives insiders an unfair advantage, so there are rules in place to make sure insiders don’t get to profit from their special knowledge. The special term for it is material, non-public information. Most of the time, this news is just earnings, but it can also be a potential acquisition, a potential bid on the company, or even the CEO hitting the road. (Although, that last one is usually disclosed right away) Since insiders are required to let the SEC know about all their trades, they’re smart to make sure there’s nothing fishy about the timing of these trades.

Back in 2001, Martha Stewart’s broker got some good insider information on Imclone, specifically about their dumpy earnings that were coming out the next day. Stewart sold her 3,928 shares (such a nice, round number) before the bad news hit the market, booking a profit of over $41k in the process. At the time, she was worth approximately $1B. That’s the equivalent of you beating up a 9 year old for his lunch money. Of course, Stewart probably didn’t think she was doing anything wrong. After all, she was just listening to her broker.

Anyway, that’s the bad insider trading. You’re going to want to avoid that. It’s okay though, since you’re clearly not important enough to get any insider information worth trading on. If you’re a hot chick who’s an intern, you might be able to figure out the CFO likes to bang hot interns, but that’s about it.

Remember when I said the SEC keeps track of insider trading? This is perhaps the greatest overlooked resource in your investing arsenal. Let’s face it, we’re all nobodies, at least in the investing world. I’m known far and wide for having a terrific blog, ruggedly handsome good looks, and a penis the size of Vermont. But even with all those advantages, I still don’t get access to the good information. I can’t go knock on a CEO’s office door and ask him what the next year is going to bring. Even if I could somehow wrangle a phone call with somebody important, they’re still not going to be completely honest with me.

Insiders have all sorts of good information at their disposal. They know what’s going on behind the scenes. They know that Johnson from sales has a major coke habit, and because of that he’s doing a horrible job running his department. They go to the trade shows. They typically have years of experience in the industry. Insiders, even when they’re not acting on special knowledge, are a terrific source of information.

And the regulator requires they tell everybody when they buy or sell, and even how much they paid per share. This information is freely available if you’re an American investor. It’s also freely available in Canada, it’s just a little harder to find.

Let me present two hypothetical situations. Insider A is a board member of a small technology company. There is typically a requirement that all board members own at least some stock, but the number is usually just a token amount, like maybe $10k worth. (Remember, board members are usually very wealthy, oftentimes retired titans of business who serve on a few boards.) Insider A has been steadily buying shares in this company, picking up $10k here and $25k there, and before you know it he’s built up a million bucks in holdings. There’s a couple other board members who are doing the same thing.

Meanwhile, we have company B. All the directors are very wealthy, yet they all only own a token amount of stock. Once top executives are allowed to sell their stock options, they do, faster than the 15 minutes of fame of whatever nobody Kim Kardashian dates next.

Do you see the difference in these two companies? One has management and board members who are confident enough about the company’s future to put up their cash. The other has insiders who are happy to accept money for their roles, but aren’t confident enough to invest in the company’s future.

Sure, this system isn’t foolproof. Only some sort of moron would go out and blindly buy shares in every company that has heavy insider buying. Many times, insiders have continued to buy shares as a company slid down the slope into bankruptcy. Or, maybe insiders are old and lazy, and they just want to keep their portfolio safe. You shouldn’t look at this as a standalone strategy.

Just use it as one of the metrics you look at when making the decision about buying a stock. If you’re undecided between two stocks in the same industry, maybe insider buying or selling can help break the tie.

Where can you find this information? For American stocks, it’s in all sorts of places. If you want to go to the source, go to the SEC and you can search there. Or, if you’re lazy like me, just look up the information using Yahoo! Finance. (They keep the exclamation point to try and fool you into thinking they don’t suck) Just find the stock page you’re looking for, and click on the insider transactions link. That’s easier than your sister. HEY-O!

For Canadian issuers, you have to go to sedi.ca, which is the closest you’ll ever get to travelling back in time to 1998. From there, you click on ‘view summary reports’ and then just enter the company’s name where prompted when you get to the next page. You might want to enter a date range as well, unless you want to sift through the last decade of insider transactions. Every insider is assigned a number, so you don’t even need to know anyone’s name. It’s dirtier when you don’t know their name, amirite fellas?

Monitoring insider transactions can be a useful tool in any investor’s arsenal. It’s the closest thing you’re going to get to actual insider trading, so it has the plus of making you feel like a badass.

Tell everyone, yo!

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