This is a guest post by the Intelligent Speculator which is a blog about investing, news and market events. It also supplies readers with free stock picks with the goal of generating new investment ideas. You can visit the blog at IntelligentSpeculator.net and subscribe to the RSS feed here.
It is always very interesting to me to hear investors looking at insider transactions to decide on buying or not a stock. Just to explain further, insider transactions are when senior executives of a company either buy or sell stocks of their own company. Executives are required to report these trades to the authorities for various reasons and there are many ways for investors to access this information. It has been used as a point of analysis by many and I have always found it simply bogus. Why? Quite easy, because you have no idea what is REALLY going on.
Let’s use an example. Say you hear about a CEO buying stock of his company or you look and see that they own a very important amount of shares and so you would automatically assume that:
-This CEO has a major financial interest in the company’s success
-This CEO believes the stock has a good opportunity to go higher (and he should know right? He is the guy in charge).
The argument is flawed on so many levels but to me the most obvious one is trades done off market. For example, let’s say the CEO of Goldman Sachs owns 1 millions shares of the company, giving him a crazy $1 million loss for every dollar the stock loses. Feel sorry for him yet? Ok maybe not. But there is potentially something you do not know.
You do know that he owns 1 million shares. But let’s say for a second that he did an off-market equity swap? Say what? Basically, he is paying the return of 1 million shares of Goldman Sachs in return for the return for the same amount of the general market. Not clear?
Basically, the CEO owns 1 million shares and will gain $1 million for any 1$ increase in the stock of the price. However, off market he must pay the return on the same quantity of stock. So basically, this CEO will not make a dime on the increase or decrease of Goldman Sachs. And how you will know he did this? You won’t. The CEO did the trade off market and he does not have to report this trade.
Why would he do that? You know, the guy did not reach the CEO status by being dumb. He might not believe the stock is going higher, but he won’t make a big announcement saying so. Instead, he will quietly make this trade (there are many different ways to do this), and feel happy to know that all investors still think he has a major financial interest in the future of his company.
So please, next time you hear someone saying you should buy a stock because the executives are buying. Please just let them know that it might be the case, but it could not be as it seems…
This concludes the guest post by the Intelligent Speculator – thanks very much for the article. You can read a little more about Equity Monetizations (the strategy referred to in the article) here.
Is this really legal? It seems to make a farce of the insider trading laws.