The Wolff is going to discuss how insider purchasing can be demonstrative of both an opportunity both in its ability to diffuse liquidity constraints, and indicating a managerial commitment to the performance of the firm as a whole. With this information, we can then begin using insider purchasing reports to gleam greater insights into the true opportunity of an investment, and better fortify the position itself.
The trick to understanding insider reports is to be able to differentiate between isolated purchases, and major trends in the volume itself. For example, if an insider is merely buying a few more units to keep up with his/her own personal portfolio, we might be mislead into thinking that the insider is gearing up for a major growth period. Similarly, if an insider is purchasing into the company all at once, and in high volume, we might be mislead to purchasing into the fund in the midst of an event that might prove to be highly volatile.
Because of this new volatility, we might have already missed the buying opportunity, and therefore not be in a position to increase the equity’s weighting. Lastly, we want to be sure that sell-offs from insiders are not being misconstrued. If a director of the company is selling shares to procure funds for a down payment on a new home, we want to be sure that we understand the one time nature of the transaction, and how it is not indicative of a greater trend.
One of the easiest ways to identify a real opportunity indication from insider buying is to see if all of the management team is buying in, or if it only a few key individuals. If the management team is already bought in, or is collectively increasing their position in the company, it indicates their confidence in the ability of the company to grow, and also reduces the liquidity risks of the security. This second point is further accommodated by the way in which insiders will usually purchase in slowly over time, providing an even volume distribution.
From there, we can take the evaluation a step further to see if there are managers from multiple companies across the industry following suit. If we notice that most of the companies in the industry are experiencing increased management buy-in, we can be fairly confident that the trend is based on the underlying fundamentals of the industry. This is indicative of an opportunity for growth, based on the ability and commitment of management to execute a strong business plan.