Insider Accumulation refers to the purchase of the stocks of a company by its insiders, including its Directors, officers and the large stakeholders. Insider accumulation has been a popular point of discussion when it comes to understanding what works and what does not in terms of investing.
It has been observed that when the insider accumulation increases, i.e. when the corporate insiders buy more shares in their own company, the outsiders also increase their investment in that stock. When the public comes to know that the insiders are buying stock, it assumes that the company is doing well and is growing or about to grow. This increases the value of the stock and the investors become bullish towards the stock and buy.
The concept has been discussed in great depth by Tweedy, Browne Company LLC in the book “What has worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns”. The book discusses:
“Investment returns associated with purchases of shares by corporate insiders (officers, directors or very large shareholders) have been examined in several studies by academicians. All of the studies assume that investments were made in the shares of companies in which (i) more than one insider had purchased a company's shares, and (ii) the number of insider purchases had significantly exceeded the number of insider sales during the same period. The studies also assumed that investments were made in the stocks that insiders had purchased shortly after it was public information that the insider transactions had occurred.
This supports the belief that when insider accumulation increases, the outsider buying also increases. According to the outsider investors, it is a positive signal and they tend to follow the movements of the insiders.
In Tweedy, Browne's experience, officers, directors and large shareholders often buy their own company's stock when it is depressed in relation to the current value which would be ascribable to the company's assets or its ongoing business in a corporate acquisition, or to the likely value of the company in the near to intermediate future. Insiders often have “insight information” — knowledge about new marketing programs, product price increases, cost cuts, increased order rates, changes in industry conditions, etc. which they believe will result in an increase in the true underlying value of the company. Other examples of insider insights are: knowledge of the true value of “hidden assets,” such as the value of a money-losing subsidiary that a competitor may have offered to buy; or the value of excess real estate not required in a company's operation; or knowledge of the likely earning power of the company once heavy non-recurring new product development costs stop. It is not uncommon to see significant insider buying in companies selling in the stock market at low price/earnings ratios or at low prices in relation to book value.
Rightly said that the insiders have direct access to the private and confidential information about the company. So, their investment increase in the company indicates that they know something which the public does not know yet, and they are taking advantage of that fact. Therefore, the outsiders tend to follow them assuming that their decision is based on certain hidden facts which are valuable.
It has been Tweedy, Browne's experience that a company will often repurchase its own shares when its management believes that the shares are worth significantly more than the stock price. Share repurchases at discounts to underlying value will increase the per share value of the company for the remaining shareholders. When officers and directors are significant shareholders, the money which the company uses to buy back its own stock is, to a significant extent, the officers’ and directors’ own money. In this circumstance, the repurchase of stock by the company is similar to insider purchases.
Similarly, stock repurchases are also considered at the same stance as insider accumulation. When the company is buying its own stock back, it indicates that the shares are worth more than their price and the share prices may soon go up.
Companies selling in the stock market at low price/earnings ratios or low prices in relation to book value frequently repurchase their own shares. Share repurchases at a pre-tax earnings yield which exceeds what the company earns on its cash or what it pays on debt incurred to fund the share repurchase will result in an increase in earnings per share. Share repurchases at less than book value increase the per share book value of the remaining shares.
Thus, extensive insider accumulation can serve as an indicator of the near-term performance of the stock. Through insider accumulation, the insiders give a vague hint that something good is coming out. This hint can be captured by the investors and used for their profits.
This concept has also led to the formulation of a popular investment strategy called the Insider Investment Strategy. This strategy follows the buying and selling decisions of the insiders. This is based on the assumption that the insiders have information advantage and they are more equipped to make profits than an average investor.
As a bottom line, Insider Accumulation can have a positive impact on the outcomes of investing, if used judiciously. So, you may go start stalking the Insiders!