Can Insider Transactions Signal Sector And Industry Trends?

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 |  Includes: DIA, QQQ, SPY
by: Sergey Gorshunov

For some wise investors, buying the stocks of rising sectors of the economy and shorting stocks of the declining sectors has, for years, been a reliable strategy. The question is how do you spot the next rising or declining industry? In this article, I will try to find the likely rising/declining sectors by employing a less than conventional method: examining the insider transactions data.

Following corporate insider transactions has been a method utilized by many traders and investors for a long time. It is a widely acknowledged phenomenon that if an insider buys a stock, this may signal future earnings growth, and, subsequently, the stock price gain. But can insider transactions in aggregate signal the direction on the broader level of a sector and industry?

At my company prognolic.com, we track the performance of every insider transaction. The first difficulty in spotting the information with the predictive power is that many transactions have absolutely no money involved. For one reason or another, corporate insiders just transfer the shares back and forth to the company. If an insider doesn't put his money at stake, we don't count the transaction as a signal. The market reacts differently to different people that report the transactions, as one very interesting research paper from Harvard professors proves. Thus, Prognolic separates the 'noise' and finds only the truly informative parts of the mass of information.

The setup of this research is fairly simple. We take all transactions that might be deemed as opportunistic trades (the transactions that insiders undertake supposedly with the intention of making profits) and examine the buy/sell ratios for every sector and industry. As I assumed earlier, if insiders mostly sell companies from a sector/industry and the ratio is low, this may indicate change of the underlying trends, and one should avoid investments in the companies of the group.

Table 1 represents insider transactions' buy/sell ratios for the sector level. Sometimes, not one but several insiders are buying/selling a company's stocks at exactly the same moment. So, in the second column, we take the number of companies in a sector that have reported insider buys and divide it by the number of companies that have reported insider sells. In the third column, we take the number of insiders who have reported on buys and divide it by the number of people who sold shares in their respective companies.

Table 1. Monthly buy/sell ratios. Sector level.

Sector

Ratio by #companies

Ratio by #insiders

%Performance - 1 month

%Performance - 3 months

Utilities

1.26

2.95

5.53

10.67

Financial

1.14

1.49

1.38

3.66

Industrial

0.52

0.88

-3.85

0.66

Basic materials

0.79

0.87

-3.93

-7.92

Cons goods

0.6

0.81

3.55

10.22

Healthcare

0.67

0.69

6.40

13.11

Technology

0.33

0.35

-0.82

0.68

Services

0.29

0.29

1.9

7.48

Click to enlarge

As you may see, according to the data, insiders are most confident in the Utilities sector and least confident in the Services sector.

The problem with sector-wide data is that this might be not informative enough for stock traders, as there is the possibility of a rising industry within a declining sector. Therefore, let's examine the same ratios on the industry level.

Top 5 monthly buy/sell ratio. Industry level.

Industry

Sector

#companies in the industry

Ratio by # companies

Ratio by# insiders

% performance - 1 month

% performance - 3 months

Water Utilities

Utilities

12

3

47

1.83

9.89

Food Wholesale

Services

7

2.1

17

1.25

9.98

Foreign Regional Banks

Financial

20

n/a

11

1.08

-1.21

Autopart Stores

Services

5

4

9.6

-2.06

10.25

Regional Southwest Banks

Financial

20

3.33

9

-1.29

3.97

Click to enlarge

Bottom 5 monthly buy/sell ratio. Industry level.

Industry

Sector

#companies in the industry

Ratio by # companies

Ratio by# insiders

% performance - 1 month

% performance - 3 months

Beverages - Soft Drinks

Cons goods

19

0.218

0.055

6.42

14.74

REIT - Office

Financial

20

0.27

0.052

5.84

6.47

Advertising Agencies

Services

11

0.21

0.05

1.25

8.85

Semiconductor - Broad Line

Technology

20

0.125

0.037

4.45

7.58

Broadcasting - TV

Services

16

0.2

0.033

2.19

7.20

Click to enlarge

Conclusion

If we combine these two tables, a main thesis can be produced out of that data: the rise of the Water Utilities, Foreign Regional and the Regional Southwestern Banking industries are supported on the sector level.The rise of the Autoparts stores and the Food Wholesale industries is omewhat contradictory to the sector direction. The Semiconductor - Broad Line and the Broadcasting - TV industries will probably decline.This data is also supported on the sector level.

Of course, this data should not be accepted as final, but rather be a starting point for thorough investigation of the industries mentioned above. It is highly recommended that we answer the following question: what might the reasons be behind a supposed rising/declining industry? I hope the parts of the mosaic will eventually match.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.