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 was intended to replace my prior Russell 2000 Reconstitution Anomaly study. However, I have extended the Russell Index Reconstitution anomaly for a third year, and the portfolio article will be released publicly this week.
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 227 purchasing transactions filed on Form 4s with the SEC from the start of April 2019 through the end of June 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 June are analyzed according to purchasing size and monthly performance relative to the S&P 500 over the same time frame.
The 227 transactions were then segmented by stocks into nearly equal quartile counts based on the dollar amounts of the CFO purchases. The 227 transactions reduced through repeated stock transactions (especially in the Under $10k segment) to 178 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 three months of the study have confirmed key findings from the published financial literature on this anomaly. While it has only been three months of data with 227 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 Zeckhauser, 2003)
According to Jeng, et al (2003), the effects occur quickly in the first 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. Wang et al. (2012) documented that these first 3 months were the strongest period for initial abnormal returns. The total returns in the first three months of this study are documented below:
|Total Return Results||>$100k||$100k to $30k||$30k to $10k||<$10k|
|3 Month Total Return||7.16%||8.29%||4.26%||0.93%|
|3 Month Winsorized Return||6.92%||7.75%||3.43%||-0.92%|
|3 Month S&P 500 Return||3.79%||3.79%||3.79%||3.79%|
Monthly Return Results
April CFO Insider transactions through June: S&P 500 gains since April are +3.79%. On the April Returns chart measuring April CFO reported purchases, the gains for purchase over $30k have substantially outperformed the lower two quartiles over 3 months. This is a very strong confirmation of the documented CFO insider trading anomaly results in the referenced literature. This is also very strong evidence that the CFO insider trading variable should be a screening factor included in most investors' selection criteria.
May CFO Insider transactions through June:
Since the start of May through the end of June, the S&P 500 has had a loss of -0.14%. Every segment beat the S&P 500 return since May, except the last quartile representing CFO purchases under $10k. The top three quartiles remained strong over the prior two months, but we can see that purchases over $30k over a three-month period have generated the best results.
June CFO Insider transactions for the month:
S&P 500 gains for June were a near record +6.89%. As good as the S&P 500 has performed, all of June CFO reported purchases by quartile above $10k managed to beat the high S&P 500 returns. This is again very strong confirmation of the documented CFO insider trading anomaly results in the referenced literature. More confirmation is also evident that you should avoid CFO insider purchases of less than $10k per transaction.
Members have full access to the V&M Dashboard Spreadsheet with the active CFO Insider Trading page and can monitor the CFO purchases as they are reported. The results above complete the 3-month evaluation period in published financial literature and confirm well-documented results presented in peer-reviewed research. It would be a mistake not to include the CFO insider trading anomaly as a variable among many other strong variables in your stock screening criteria. 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 the best performing stocks 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)||62.26%|
|Chewy, Inc. (CHWY)||59.09%|
|Nabors Industries Ltd. (NBR)||43.07%|
|NCS Multistage Holdings (NCSM)||35.50%|
|Exela Technologies (XELA)||32.73%|
Another sample of five stocks from the full list of the best stocks by performance 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)||54.59%|
|Coeur Mining, Inc. (CDE)||52.82%|
|Hi-Crush, Inc. (HCR)||51.66%|
|Grocery Outlet Holding Corp. (GO)||49.45%|
|DASAN Zhone Solutions, Inc. (DZSI)||33.23%|
"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:
- CFO Insider Trading Anomaly For June: Biggest Buys Yielding Best Returns
- CFO Insider Trading Anomaly: April Results +4.53%
- Top 10 CFO Insider Stocks Ranked By 6 Quantitative Models For May
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 three months of this research are already producing strong confirmation that supports 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.