This article continues my monthly analysis of the live testing of the CFO Insider trading anomaly study that began at the start of April 2019. The purpose is to retest highly profitable aspects of peer-reviewed research in the financial literature for the next 12 months. This new anomaly study is replacing my prior Russell 2000 Reconstitution Anomaly study that concludes a two-year evaluation today and is summarized in a separate final performance results article.
Instinctively, we know that corporate insiders have the best information to conduct potentially profitable purchases and sales of their company stock. The basis of the CFO insider trading anomaly stems from a number of different conclusions in the financial literature to harness the best performance results:
- "Insiders have far superior knowledge about the company and the industry than the market" (Singal, 2004, p. 134)
- "CFOs derive statistically and economically higher abnormal returns from their purchases of company shares than do CEOs. Furthermore, CFOs' excess return is robust to controlling for risk factors. (Wang, Shin, & Francis, 2012, p. 758).
- "Our results are consistent with CFOs utilizing more (superior) information in their purchase transactions compared to CEOs. The excess returns by CFOs persist even after the trading information is made public, suggesting that the market is slow in incorporating the information in CFOs' trades" (Wang, Shin, & Francis, 2012, p. 758).
- "A firm is likely to perform better following an insider buying month than an insider selling month. Overall, it can be seen that stocks of firms where insiders have been actively buying outperform stocks where insiders have been actively selling. The difference in returns over the subsequent twelve-month period varies from 4.8 percent to 18.7%." (Singal, 2004, p. 139).
If we want additional trading advantages, it makes sense to look to insiders' trading behaviors. If we want to harness the best possible results, it makes sense to look at the most successful group of insiders, namely CFOs, according to published research. If we want to find the best results from the CFOs, we begin to analyze their purchases in the research that follows.
My current CFO Insider Trading research study consists of 146 purchasing transactions filed on Form 4s with the SEC from the start of April 2019 through the end of May 2019. The longer-term insider reporting Form 5 is not included in my study due to the lack of immediacy that the Form 4 filings provide us. Form 4 purchasing transactions are being accumulated as part of a longitudinal study to live test the findings in published financial literature to see if abnormal returns result in active market trading.
These transactions through the end of May are analyzed according to purchasing size and monthly performance relative to the S&P 500 over the same time frame.
The 146 transactions were then segmented by stocks into nearly equal quartile counts based on the dollar amounts of the CFO purchases. The 146 transactions reduced through repeated stock transactions (especially in the Under $10k segment) to 123 unique stocks across quartiles as follows:
Comparisons were then made between each of the quartiles and in relation to the benchmark S&P 500 performance for this time period. A further step was taken to Winsorize the data samples by removing the two highest and two lowest outliers from each quartile to help reduce skewing from outliers. Results of the study through the end of May are shown below with both the raw returns and Winsorized performance results.
The results of the CFO Insider Trading research over the first two months of the study are already supporting key findings from the published financial literature on this anomaly. While it has only been two months of data with 146 transactions, prior studies support the strong early performance results by CFO purchase transactions.
"Most of the outperformance by CFOs occurs in the first 9 months, especially the first 3 months after they buy stocks. After their purchases, CFOs on average outperform CEOs by 2.58% in months 1-3, 1.17% in months 4-6, and 1.02% in months 7-9." (Wang, Shin, Francis, 2012, p. 744)
Because prior financial research has shown that CFOs and CEOs outperform all other insiders based on their purchase histories, this live trading study is focused on the CFOs in particular. CFOs have been well documented to outperform CEOs and all other qualified insiders who are required to submit Form 4 to the SEC, and we are most likely to see the best results among this data sample.
"Approximately one-quarter of the abnormal returns on [CFO] purchases were yielded in the first five days, and half of the abnormal returns were yielded in the first month" (Jeng, Metrick, and Zenghauser, 2003)
According to Jeng, et al (2003) is not too soon to consider these two months of CFO purchase data for abnormal returns. In fact we are well within the period where as much as 50% of the abnormal returns are realized.
|Total Return Results||>$100k||$100k to $30k||$30k to $10k||<$10k|
|2 Month Total Return||-0.57%||-0.90%||-4.58%||-5.74%|
|2 Month Winsorized Return||-2.39%||-1.91%||-3.97%||-5.94%|
|2 Month S&P 500 Return||-2.91%||-2.91%||-2.91%||-2.91%|
Monthly Return Results
April was a very positive month with an S&P 500 gain of +3.93%. The best performance of the CFO insider anomaly was clearly among the 28 stocks in the quartile where CFOs purchased more than $100k of shares in their own firm and gained +8.39%. The month of May had an average S&P 500 loss of -6.58%. There was no strong discernable difference by quartile, and every segment beat the S&P 500 return for May. In total the average CFO insider trades beat the S&P 500 for May by 3.95% with an average loss of only -2.63% compared to the Index loss of -6.58%.
Members have full access to the V&M Dashboard Spreadsheet with the active CFO Insider Trading page and can monitor the June CFO purchases as they are reported. The results above tell us some specific areas to focus on in for June. Look for the largest purchases by CFOs above $30k and especially those above $100k as they are reported to the SEC on Form 4. It is also likely that the larger the purchase relative to the market cap of the stock, the more significant the future performance outcome. I will examine this documented phenomenon in future articles.
"We also find that CFOs' outperformance concentrates in smaller firms, consistent with Lakonishok and Lee (2001), with CFOs obtaining higher abnormal returns in the smallest 3 size quartiles, but not in the highest size quartile." (Wang, Shin, Francis, 2012, p. 745)
Additionally, consider these top stocks from April and May for continued excess returns based on prior research findings from the financial literature:
"CFOs' superior abnormal returns were still earned well after the filing dates when their trades are publicly disclosed. CFOs still find statistically and economically significant outperformance over CEOs. In a 12-month period measured after the filing date, CFOs outperform CEOs by 4.62% in purchases. Again, most of the outperformance occurs in the first 9 months and especially in the first 3 months of the accumulation period." (Wang, Shin, Francis, 2012)
A sample of five stocks from the full list of strong potential stocks from April and May are organized below into two tables based on the size of the CFO purchase and the total return since that purchase was transacted.
|Best Stocks Since CFO Purchase > $100k||Total Return|
|Tradeweb Markets, Inc. (TW)||67.00%|
|Brigham Minerals, Inc. (MNRL)||14.06%|
|CenturyLink, Inc. (CTL)||6.52%|
|Coty, Inc. (COTY)||5.20%|
|The Hershey Company (HSY)||2.22%|
Another sample of five stocks from the full list of the best stocks by performance for April and May based on CFO purchase amounts between $30k and $100k. The anomaly literature suggests these stocks are all still within the time period for predicting significant excess returns and should predict earnings surprises according to Ke et al. (2003) and Wang et al. (2012).
|Best Stocks Since CFO Purchase $30k to $100k||Total Return|
|Apogee Enterprises, Inc. (APOG)||29.00%|
|FVCBankcorp Inc. (OTC:FVCB)||9.70%|
|Babcock & Wilcox Enterprises (BW)||5.50%|
|Sleep Number Corporation (SNBR)||3.69%|
|Heritage Insurance Holdings, Inc. (HRTG)||2.09%|
"Research has suggested that insider trades reveal information about the firm's future earnings performance (Piotroski and Roulstone (2005), Ke et al. (2003)). Insider stock trades should predict subsequent earnings surprises, that is, earnings changes that have not been anticipated by the market." (Wang, Shin, Francis, 2012, p. 758)
This study is exclusively focused on live forward results and will retest key findings from multiple studies in a live trading format verifiable by readers over the coming year. Research experts may appreciate that this study avoids back-testing that is prone to errors, to data-mining tricks that may harness favorable historical peaks/valley timing of market pricing, and to other such arbitrary adjustments that tend to achieve seemingly significant results.
Prior articles on this active anomaly research study can be found here and in my article and blog history:
I will continue to closely monitor the behavior of this anomaly for excess returns through the year with different analysis and insights as it progresses. The first two months of this research are already producing favorable results that support many findings in prior research studies. Further analysis is likely to yield more insights into leveraging the best trading advantages of the CFO insider purchases that are among the most profitable trades of all insiders. I trust these articles examining the unique financial anomaly greatly benefit your trading results in the years to come!
All the very best to you in your investment decisions!
JD Henning, PhD, MBA, CFE, CAMS
Jeng, L. A.; A. Metrick; and R. Zeckhauser. "Estimating the Returns to Insider Trading: A Performance Evaluation Perspective." Review of Economics and Statistics, 85 (2003), 453-471.
Ke, B.; S. Huddart; and K. Petroni. "What Insiders Know about Future Earnings and How They Use It: Evidence from Insider Trades." Journal of Accounting and Economics, 35 (2003), 315-346.
Lakonishok, J., and I. Lee. "Are Insider Trades Informative?" Review of Financial Studies, 14 (2001),79-111.
Wang, W., Shin, Y. C., & Francis, B. B. (2012). Are CFOs' trades more informative than CEOs' trades?. Journal of Financial and Quantitative Analysis, 47(4), 743-762. Doi: 0.1017/S0022109012000257.
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Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.