The Easiest Way to Improve Returns
Buying shares of a company online is less complicated than ordering a pizza.
You just enter the ticker symbol and how many shares you want and press “submit order.”
It doesn’t get much simpler than that.
But buying shares of a good company – an investment that’s going to generate strong income and/or life-changing returns?
That’s far more difficult.
To do that, you need to understand the difference between good and bad valuation metrics.
You need to know whether a company’s growth opportunities are solid…
Whether revenue and earnings are beating expectations…
And whether management is intelligent and is overcoming the challenges that hound its competitors.
The list goes on and on.
And even if it all looks perfect, a black swan event could swoop in out of nowhere and turn a sweet-looking opportunity sour.
But understanding the importance of one indicator could be the key in this hazy, volatile environment.
A Breakthrough Five Decades in the Making
In 1968, James Lorie and Victor Niederhoffer published a paper that would forever alter investing.
You probably haven’t heard of them. They’re not household names like Warren Buffett, Benjamin Graham or Charlie Munger. But I guarantee you have heard of the strategy they uncovered – even more than a half a century later.
Their research, published in an article called “Predictive and Statistical Properties of Insider Trading,” uncovered findings that countered long-held beliefs at the time. They showed that it was indeed profitable to follow insider buying.
Company executives and directors must make a disclosure whenever they purchase or sell shares. And because insiders know better than anyone else how their companies are faring, watching what they do can help predict whether a company will move up or down.
In the 1980s and 1990s, Nejat Seyhun picked up where Lorie and Niederhoffer left off. He published the papers “Insiders’ Profits, Costs of Trading, and Market Efficiency,” “The Information Content of Aggregate Insider Trading” and “Why Does Aggregate Insider Trading Predict Future Stock Returns?”
(Look, academic papers don’t have sexy titles, but the information in them is quite attractive.)
Seyhun looked at more than 60,000 insider purchases and sales transactions. And he found that insiders could indeed predict future “abnormal” returns. For instance, insiders often increased their share purchases before a company’s stock took off.
Seyhun would eventually write a book on the subject, Investment Intelligence from Insider Trading.
In the decades since it was published, there has been even more research on the impacts of insider purchases and sales. And all of this research has come to the same conclusion: Following insider buying leads to above-average returns.
In fact, Kaspar Dardas’ “Identifying Profitable Insider Transactions” found that high-conviction insider purchases produced excess returns of 20.94% over the first 12 months!
Meanwhile, a three-decade study titled “Cluster Trading of Corporate Insiders” uncovered an even more profitable trend in insider purchases. It found that cluster buying – when multiple corporate insiders buy shares in a very short period of time – was a major profit catalyst.
Following cluster buying doubled the returns of following normal insider purchasing in the first 21 days. And as time went on, the performance spread only grew wider.
The One Indicator With True Insight
The markets hate uncertainty. They fluctuate on a lack of clarity.
And when the level of uncertainty is high – as it is now – the likelihood of volatility increases exponentially.
But there is a telltale sign of confidence investors can turn to: insider buying.
Following the moves of insiders is one of the best windows into a corporation’s health. And more than a half-century’s worth of academic studies – since Lorie and Niederhoffer’s seminal 1968 paper – have shown that following insiders produces excess returns, time and time again.
Ignoring the broader markets and simply focusing on individual companies can help eliminate questions of whether investors missed the bottom or are buying at the top. And insider actions can provide even more insight into this.
Here’s to high returns,
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