Imagine if you’re buying a stock that the company’s CEO is aggressively dumping. What would you do? Insider trading of a company may offer hints as to where the stock may be going.
In this article, we answer the key questions on how to improve returns by tracking insider trading. From how to track insider trading to how to read SEC Form 4, everything you need know, we got you covered!
In addition, we look at a real-life example on how you should include this simple yet powerful tool in your investment process. In our previous article, we discussed about the importance of tracking insider ownership. This is a continuation of the technique that we absorbed in our investment process.
The term “Insider Trading” is more frequently used in the US, whereas “Director Dealing” is more commonly known in the UK. There are two forms of insider trading, namely, legal and illegal. We will be referring to the former for the entirety of the article.
What is insider trading?
Insider trading refers to transactions executed by insiders (management team, directors) of its shares, options, bonds, warrants etc. These includes buys and sells. The term “insider trading” has somewhat caused confusion among new investors, with many seeing this as an illegal practice.
Why is insider trading important when investing?
Before we go into the details of why tracking insider trading can be useful, let’s examine the motivation behind insider trading. Two things to keep in mind. First, insiders are likely to have better info than us outsiders. Second, no one (including insiders) likes to lose money. Having these in mind, it is interesting to see when insiders trade in large volumes.
“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise” – Peter Lynch
Beyond the idea that insiders know something we don’t know, there can be other reasons why insiders sell stocks from time to time. Here are a few of them
- To cover tax liabilities
- To be tax efficient
- To buy themselves a new Tesla and whatnot
The bottom line is investors should pay extra attention when there are significant insider trading. This is not a fool proof method, but it does enhance the level of conviction of your investments.
How do we look for insider trading data?
In the US, the Securities and Exchange Commission (SEC) requires companies to file a Form 4 in the event of any change in beneficial ownership of insiders. This Form must be filed before the end of the second business day following the day which the transaction was executed.
Likewise, in the UK, director dealings, as is known, are required to be reported to the regulator not more than four business days post the transaction.
How to read SEC Form 4?
That’s the hard part done, now we look at how to read a SEC Form 4.
To build a picture of what’s going on, there are 6 things you need to extract from the Form 4.
- Date of transaction
- Position in the company
- Number of shares
- Bought (A for acquired) or sold (D for disposal)
- Average price
In this particular example, we know that on 6 July 2020, Stephen Hoge, the President of Moderna Inc., transacted twice. He acquired 10,000 shares at $0.99 (granted from the options) and subsequently sold 10,000 shares at $58.48.
How to track insider trading?
Besides the methods discussed above, here are some free and insightful insider trading screeners we use as part of our investment process
Single stocks screeners
- SecForm4 for US stocks. This provides the original Form 4 Filings, breakdowns of significant buys and sells of stocks and options. I
- StockMarketWire for UK stocks
US congress insider trading screeners
How to improve returns by tracking insider trading?
Here are few things on insider trading that can help improve your investment returns
- Stocks that have significant insider ownership is usually a good sign. The rule of thumb is ~1.5%.
- Stocks that experienced continuous selling may require more attention. Of course, the opposite is a good thing to have.
- It is always useful to look at the % of shares owned before and after, over a period to determine the extent of the issue. We shall see this in an example below.
- A big red flag if insiders are dumping stocks while its stock continues to fall. Cannot stress this enough.
A real-life case study: Moderna Inc.
Who is Moderna?
Moderna (MRNA) is an American biotechnology company focused on drug discovery, drug development and vaccine technologies based exclusively on messenger RNA (mRNA).
Currently a leading contender in the COVID-19 vaccine race, the crisis has led to an astonishing +430% return year-to-date. At the time of writing, it has a market cap of ~$31 billion, despite never having a licensed product!
Why is Moderna an interesting case study?
Besides the delightful news about its vaccine development progress, there is also an equal but opposite news regarding its insider trading lately, which is somewhat unnerving for investors. With headlines like these, one must really wonder what the hell is going on.
- 22 May 2020: Moderna unveiled encouraging coronavirus vaccine results. Then top execs dumped nearly $30 million of stock
- 21 July 2020: Moderna executives hiked their stock sales after announcing positive vaccine trial
Here’s a graph of insider trading that took place during this year so far. Sea of reds.
Contrary to the graph, there is actually no evidence of outright/open market purchase since the beginning of the year. This simply means that insiders have not bought any stocks outright in the market.
Almost all insider buying were due to previous stock options that are now vested and exercisable. In most cases, stock options were immediately exercised and sold out in the market. Moderna’s management team have also implemented the 10b5-1 plan.
What is a 10b5-1 plan?
Insiders trading are tightly regulated with many rules pertaining when a trade can be transacted. Rule 10b5-1 Trading plan is one of them. Essentially, this is a pre-determined (hence no direct interference from the owners on timing etc) trading plan that will be executed passively over a certain time period.
These arrangements are required to be set up at least 30 days prior any transactions are executed. Optically, this is to prevent any concerns of trading on non-public info.
A detailed breakdown of Moderna's insider trading
|Stephane Bancel||Chief Executive Officer||655,825||$43.94||$28,819,152||31,586,769||2%|
|Tal Zvi Zaks||Chief Medical Officer||970,368||$63.44||$61,560,978||1,075,705||90%|
|Lorence Kim||Chief Financial Officer||1,126,600||$59.41||$66,934,360||3,104,272||36%|
|Juan Andres||Chief Technical Officer||237,843||$52.30||$12,439,026||671,391||35%|
Despite the CEO, President and Chairman’s incessant selling of its stock, it remains a miniscule proportion of their total ownership. Interestingly, Elizabeth Nabel and Tal Zvi Zaks, a director and Chief Medical Offer, respectively, have sold almost all of its holdings.
On the other hand, the table on the right paints a big picture of Moderna's insider trading since beginning of the year. The insider's ownership remains high at 27.8%, albeit a small decrease from 29.2% earlier in the year.
It remains up to investors' interpretation of the average selling price of insiders at $55.76 per share vs the current price of $80.86. Lastly, the total dollar value sold by insiders amounts to 0.9% of its current market cap.
There is no doubt that the headlines look suspicious, but Moderna’s top insiders, namely the CEO, President and Chairman, continue to have significant holdings in the company.
In summary, insider trading may provide additional clues to your investment case. Analyzing and tracking insider trading should be a supplement to your investment process, not a substitute.
The key takeaways are
- Stocks that have significant insider ownership and considerable insider buying is usually a good sign.
- Useful to consider the % of shares owned before and after, over a period to draw a more rounded conclusion.
- If insiders are dumping stocks while it continues to fall, RUN!