There are a lot of investors who pay close attention to insider buying. If the CEO, board of directors, or even just some big investor is purchasing shares, they view it as a bullish signal.

Generally, I tend to agree with this type of thinking. There’s really only one reason to buy a stock, and that’s GOOD OL’ FASHIONED GREED, BABY. Gordon Gekko just called and he wants me to tell y’all he gets hard every time somebody talks like that. I’ve since blocked his number.

There might be only one reason to buy, but there are a million reasons to sell. You might be nervous about having too much of your wealth tied up in one company. Your wife might want to remodel the kitchen or your damn kids might be insisting you pay for their college. Bastards. There might be a better investment opportunity somewhere else. Or maybe cash needs to be freed up to pay the very reasonable estate fees from the late King Olubuse II. And then we’ll totally split the proceeds.

That was an actual Nigerian king, btw. And apparently there’s a conspiracy theory that he’s not actually dead. He’s just chilling in London enjoying life as an old rich guy. Like every conspiracy theory, I choose to believe this one without any critical thought. Have I told you guys that Fidel Castro is totally Justin Trudeau’s dad?

Let’s get back to the topic at hand. Should you look for significant insider buying when looking at a stock? Let’s look at the pros and cons.

Pros

As previously mentioned, the logic goes buying = good. We’ve already covered that, so let’s move on.

Just how good is this buying? There are various studies that I’m clearly too damn lazy to read, but I think I’ve gotten the gist of them. There’s definitely a short-term outperformance when insiders buy shares. They tend to beat the overall market by about 3-5% over that first year, which is certainly nothing to sneeze at. But there’s also scant evidence this outperformance continues for the long-term. Insiders get their nice gain and then hold for a little while, getting out when things look much better.

Everybody pays attention when the stock is beaten up and insiders are buying. Nobody cares once the selling happens. The stock has already recovered and people have moved on.

This all comes down to the powerful concept of having skin in the game. Somebody who’s buying is putting their money where their mouth is, and that’s a good thing. Even short-term outperformance is still beating the market, which is exactly what we’re looking for.

And remember, we don’t necessarily need insider buying to have skin in the game. If a CEO already owns a bunch of the stock then we’ve already got it.

Cons

I think that looking squarely at insider buying may not be the best way to build your overall portfolio.

Any value investor has stories about some beaten-up stock they bought partially because of heavy insider buying. For me, that company was Penn West. The stock was cheap, oil was about to recover, and insiders were spending millions of their own money slurping up shares. So I bought and the company promptly fell further into the toilet.

I think I took about a 75% loss on that one, which hurts. But it would have been a 90% loss if I would have held on until today. I will take that small victory, thank you very much.

If you take a look at Canada’s biggest and arguably most successful stocks, you barely see any with significant insider ownership. Canada’s banks don’t have big insider owners. Neither do the pipelines. Both Rogers and Shaw have a decent amount of insider ownership, but they’re minority stakes that control the company through multiple voting shares. Same with Couche-Tard.

It proves you don’t need to own stocks with high insider ownership to do well. Managers have incentive to do well even without putting their own money to work. It turns out fear of losing your multi-million dollar annual salary is a pretty good motivator.

Wrappin’ it up

Here’s the way I see it. If I have two stocks I’m weighing buying and they’re identical in every way except one has insider buying and the other doesn’t, I’ll probably go with the insiders. There is a certain predictive power there that works, at least generally. Individual results might vary.

But I would encourage anyone to look beyond insider buying. It’s a nice signal, but it’s not the only key to picking good investments.

Tell everyone, yo!