Remember, Insiders Can Lose Their Shirts Too

The title of this article may surprise some of my long-time readers. From 2004-2008, I covered insider trading for an independent financial research firm. During that time I learned a lot about insiders and their ability to forecast major trends in the market.

However, I also learned that the assumption that insiders somehow know something outside investors don’t is overly simplistic if not outright false.

In 2007, insiders continually loaded up on financial, mortgage lender, and homebuilder stocks. With very few exceptions, all of them were wrong. And nearly everyone who followed insiders into these sectors—including myself at the time— lost money.

Amazingly this was the case for countless insider purchases. And when I say “insider” I’m not just referring to any old senior VP or recent addition to management; I’m talking about founders, CEOs and people who have been involved with these companies for decades.

Consider Garrett Thornburg of Thornburg Mortgage (TMA).

Garrett founded TMA in 1993. It was his third business—he founded Thornburg Investment management in 1982 and Thornburg Securities in 1984. So Garrett has 15 years in the mortgage lending business as well as 25 years of experience with investing and financial analysis. Obviously this guy has a great deal of specialized knowledge and insight.

But this didn’t stop him from losing a fortune buying shares in TMA’s stock during 2007. As the mortgage meltdown spread and bank lending contracted, TMA shares plunged from $26 down to $0.65 where they trade today. Garrett bought all the way down, losing close to $26 million in the process.

He wasn’t the only one losing his shirt.

Alan Bernon was president of Dean Food’s (DF) dairy group in 2007. I say “was” because Alan was unexpectedly ousted in September of last year.

However, prior to his removal, Alan purchased more than $13 million worth of DF’s stock. And he did this at a time when milk prices were hitting record highs due to the rise in cow feed and other factors. DF had already lowered its 2007 outlook due to its rapidly diminishing margins.

Seeing this, it was tempting to simply assume Alan was an idiot. However, Alan had worked in the dairy industry for well over 30 years. His grandfather, Israel Garelick, founded Garelick Farms in 1931. Alan joined the family business immediately after graduating from college in the mid-'70s.

He was bought out by DF in 1997 and worked his way up the corporate chain of command to Chief Operating Officer and President of Dean’s dairy group. In simple terms, this guy knew a heck of a lot about the dairy industry. So you would think his purchases indicated that the worsening economics of the dairy industry were overblown and DF shares would quickly rebound.

Wrong again.

Bernon started buying around $46 per share. He bought all the way down to $26. And DF’s stock is now at $18 and change.

These are just two of the countless scenarios that unfolded last year. Time and time again insiders with decades’ worth of industry experience lost their shirts. It really made me question just how insightful insider trading can be.

Please understand, I’m not saying that insider trading—particularly insider purchases— offers no value at all. I’m simply saying that you can never assume an insider knows a whole lot more than you do.

Always do your own due diligence. If the economic data and overall trend don’t support an investment, don’t blindly follow an insider into a trade. These guys can lose their shirts just like you or I.

The only difference is that you and I won’t receive stock grants next year.

Comments

[Things ComeUndone]

Has anyone done a study of insider trading to determine the win/lose percentage?

[alphameister]

Good article. I value the information provided by insider trading, especially on the buy side, but it's never a primary factor in making my investing and trading decisions.

[notsosmart]

so 2 were wrong. how many laughed on the way to the bank while the "unmentioned,unca... about shareholders" were left holding the bag.