How to profit from insider trading (legally)

What comes to mind when you think of the term “insider trading”? Many people think of financial crime, fraud, scandal… maybe even American home-decorating mogul Martha Stewart (indicted by a U.S. federal grand jury in 2003 on nine criminal counts, one of which was securities fraud).

The reality, however, is that insider trading is perfectly normal. For the most part, it’s mundane. It’s an everyday occurrence that – if the timing is right – is completely legal.

Insider trading is simply buying and selling of stock by company insiders (like senior executives and board members), who have access to non-public information about the company (like up-to-date sales figures, plans for expansion or internal projections).

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It’s insider trading that isn’t legal that grabs the headlines… the investment banker working on a confidential acquisition transaction who tells his buddy to go buy stock in the target company, for example. Or the husband who, after his partner shares some negative insider news about the company she works at, goes and shorts (i.e. bets against) the company stock. This is insider trading that’s breaking the law.

But that’s not what we’re talking about today.

Insiders know best

You see, everyday, legal insider trading can potentially offer us some clues into a company’s prospects. Because someone who knows a lot about the inner workings of a company – more than the public – choosing to buy, or sell, shares of the company can (though not always) be a very powerful indicator.

To determine how “powerful” the indicator is, let me outline a few considerations.

Firstly, what is the seniority of the individual doing the trading? Insider trading by a CEO is typically more consequential than a mid-level employee. This is purely because we should assume on average that C-suite executives know more about the company than less senior employees.

Secondly, how many insiders are trading? If it’s limited to one or two people, then there’s less importance to what we see. On the other hand, if there are a handful of senior execs all buying or selling at around the same time, it’s worth paying more attention.

Thirdly, the size of the company is important. Smaller sized company management often has a much better “big picture” view on the health and prospects of their company, than, say, a senior executive of a blue-chip behemoth.

Finally, are the insiders buying or selling? Insider selling isn’t necessarily a bearish indicator, unless it’s widespread and consistent. One individual may be making a personal asset allocation decision to diversify (if company stock accounts too much of his portfolio, for example). Or he may be selling because he has to pay for his kid’s university fees. Most of the time, we have no way of figuring out why a person sells.

But insider buying is another story…

Today’s powerful insider indicator

I become very interested in a stock when I see senior insiders of small-cap (market cap of US$300 million to US$2 billion) companies buying it.

What’s the logical explanation for that? Either they are trying to send a message to the market that the company is in great health (although it’s potentially costly way to do that!). Or more likely, they are positive on the business and they think the stock is very under-priced.

Incidentally, that’s the exact set up we have for our recommendation is this month’s edition of The Churchouse Letter… It’s a small-cap, under-the-radar stock. The core luxury products it crafts are considered “works of art”, with prices to match. Despite roots that trace back hundreds of years to one of Asia’s wealthiest families, I’ll hazard a guess that 95 percent of our subscribers have never even heard of it.

And the chairman (who is the majority shareholder) has just bought more shares.

Don’t get me wrong – this isn’t the only reason we’re recommending this stock. We also believe it’s very cheap on a valuations basis, considering it’s a fast-growing prestige brand.

And we think that over the next year the share price could easily double.

High-powered insider buying of an obscure, unheard of stock like this is a compelling bullish indicator

Good investing,

P.S. Two days from now we will reveal this company in this months’ edition of The Churchouse Letter. Click here to subscribe.