Returns: The Insider Story
George Mangione already has three computer screens on his desk, but I'm sure he'd add a fourth if it would give him an additional edge. A well-built guy with brush-cut hair and rapid-fire speech, Mangione honed his competitive streak on Brooklyn baseball diamonds, playing center field for Canarsie High back in the early 1980s. These days he's the equity strategist for Ladenburg Capital Management in Bethpage, Long Island. Mangione is a quant, which means that his stock picks are based more on quantitative measures of company and stock performance than on the underlying businesses. Companies that meet his criteria go on his roster; those that cease to do so get dumped with all the sentimentality that George Steinbrenner reserves for sluggers past their prime. "Hope," Mangione tells me, "is for sick people. We go by the numbers."
Some of those numbers you'd recognize -- earnings and revenue growth rates, for example. But what prompted me to visit Mangione was the fact that he chooses a few of his stocks based on a different set of stats: data on stock purchases made by corporate insiders. I'd been thinking a lot about such transactions, partly because of stories detailing well-timed stock sales by executives at Enron and Global Crossing, and partly because of the big role that company stock now plays in the compensation packages of most corporate leaders. I hoped that Mangione could shed some light on a question that has fascinated Wall Street forever and seems especially timely now: Can outside investors improve their decisions by watching insiders?
The logic in favor of tracking insiders is compelling -- most of all, perhaps, to investors who run businesses themselves. The folks steering a company, after all, are the first to know if it's about to land a big contract, make an R&D breakthrough, or suffer a setback. And for the most part it's perfectly legal for executives, directors, and major shareholders to buy or sell stock based on what they know, so long as they disclose all transactions.
Hence the plethora of insider-reporting services. Pull up a stock on Yahoo Finance, for example, and a summary of insider transactions is one of your many options. Click on it, as I always do, and you have the key to -- well, to something or other. Let's see: Is the chief financial officer of Company A selling because he's bearish or because he's building a vacation home? Is the CEO of Company B buying because she's smart or because she's as bad at predicting demand for her shares as she is at forecasting sales of her products?
Now, I don't think Mangione or anyone else will ever devise a foolproof algorithm for converting this wealth of data into a wealth of wealth. But when I visited Ladenburg, I did find that the numbers-focused strategist had some handy rules for boiling the stats down to some interesting "buy" recommendations. They go like this:
Watch buys, not sells. Insiders have many reasons for selling but really only one (a potential profit) for buying. And when Mangione refers to "buyers," he doesn't mean people who are simply exercising options they've been granted. "We want to see them spending real money, buying significant amounts of stock in the open market," he says.
Watch the right buyers. Some insiders buy at the wrong time; others aren't really in the know about their company's prospects. Mangione uses a 10-year database of insider transactions to spot corporate decision makers with a track record of successfully investing in their own stock. To be worth pursuing, he figures, the stocks need to have shown returns of 15% or better in the six months after their purchase.
The more buyers, the better. When the boss buys, it's interesting. When the boss's purchases are emulated by a bunch of vice-presidents, Mangione starts to think he may be looking at something meaningful.
So how has Mangione done with his screening method? From March 2001 through March of this year he had picked the only 12 stocks -- all of them big, liquid issues -- in the universe of U.S. publicly traded companies that had insider purchases satisfying his criteria. (For a recent pick, see "One Stock," below.) After one month, 10 out of the 12 were gainers, returning an average of 14.7%. After two months there was one loser (a different one), and the average gain was a seductive 28.4%. Pretty neat, but remember: this is a small sample in a limited period. Furthermore, there remains the crucial question of whether and when to sell. The price rises weren't always sustained.
For Mangione, whose strategy calls for lots of trading, that's not necessarily a problem. (His selling criteria? Suffice it to say they're more qualitative than quantitative, though he does move stocks off his list six months after the most recent insider purchase.) However, Mangione is a pro; he even runs a small hedge fund, in addition to finding stocks for Ladenburg's brokers to sell to clients.
For the typical Inc reader who isn't (and shouldn't be) an active trader, there's something else here: a few conceptual tools for adding insider transactions to the list of factors you consider when evaluating a stock. If the people running the company think it's a bargain, maybe it really is.
Financial writer Kenneth Klee writes Returns monthly.
In early April, Ladenburg Capital added horse-track owner and operator Magna Entertainment to its "Insider Alert" list of recommended stocks. The brainchild of auto-parts tycoon Frank Stronach, Magna is buying up premier tracks (including Santa Anita Park, outside Los Angeles, and Gulfstream Park, near Miami) and bringing them into the Internet age. Sales of real estate accounted for a big chunk of the company's 2001 profits (about $13 million on revenues of $519 million), and a two-class stock structure (which gives parent Magna International almost all voting power) looks shareholder unfriendly. On the other hand, Stronach bought about $604,000 worth of those voting-impaired shares over the course of 2001.
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