4/26/2015

WHAT HAPPENS, Blindly Buying Micro Cap Value the Day after Reported Insider Buying?


Alpha is created as an aggregated GROUP.  But can we improve and avoid those stocks that drag down aggregated returns following this method?

Insiders must use public information. Their advantage is interpretation of this public data. However, most insider trading data is noise.

The topic of insider trading has been rigorously studied. Findings published in academia and for profit firms. However, following insider trading activity is not a magic solution, get rick quick scheme. Countless insider trading newsletters have failed to justify their existence. They folded by over relying or simply misinterpreting information and ignoring financial and capital structure red flags. But having said this, studies have shown correctly using insider trading activity does have predictive market outperforming value. 

A summary of key points for using insider trading

    Less efficiently priced small companies with insider activity provide more market outperforming information. There’s a negative correlation (inverse relationship) between companies size and its insider activity forecasting value.
 
      Insiders have a greater understanding of their business economics. Officers (CEO, CFO) have the most accurate record. Large shareholders provide the least predictive value but shouldn’t be ignored.
 
      Purchases contain more information than sales. But multiple insider sales with a high short position can reveal potential company negatives.
 
      Consensus activity increases the predictive information of the insider trades. So a diverse group of buyers has more predictive value than one insider.
 
 
      The size of the transaction is proportionally important. I prefer to use the ratio of shares purchased to shares in the float to measure buying conviction. Further, I give more weight if the percentage of insider ownership is high before the insider activity.
 
      Analyze open market transactions; give less importance to private transactions.
 
      It seems logical insider activity within certain industries such as biotechnology may provide more directional information. The thesis is management understands the science and future possibilities of new drug breakthroughs or ability to pass future FDA hurdles. Other specialized industries should also be given a closer look.
 
 
“Several academic studies have been done over the years exploring the outperformance of insider trades and specifically insider buying. These studies have analyzed data over several decades and have shown that insider buying tends to outperform the overall market by 6% to 10.2% per year depending on which academic study and time period you look at.

According to the Wharton study “Estimating the Returns to Insider Trading” that looked at a comprehensive sample of insider transactions over 22 years from 1975-1996, about one-quarter of these abnormal returns accrue within the first five days after the trade and one-half accrues within the first month. You can read this research paper along with several other related papers below.”  Source  http://www.insidertrade.net/academic-research/



For this post, I will use the micro cap insider buying shared over the past 2 months. One goal is to uncover additional metrics that can improve the directional value of using positive insider activity.  This will require several posts.
I made the following observations.
Dig dipper into stocks listed on OTCBB, OTCPK. These companies are inefficiently priced. They hide in the shadows of Wall Street with little or no institutional coverage. I’m only saying there may be hidden opportunity in this group. It’s also an area with the most garbage, be careful.
Examples of actual shared ideas meeting this criterion over past 2 months are;
Frontier Oilfield Services, Inc. (FOSI) reported insider buying on 03/09/15. The following day’s price .90 versus current price of $2.94 (226% change in price), Further, additional buys reported 03/12/15 and 03/20/12. Buying the day after for would create potential outstanding returns. Furthermore, Spindle, Inc. (SPDL), Patent Properties, Inc. (PPRO), ICTV Brands Inc. (ICTV), Research Solutions, Inc. (RSSS), Cocrystal Pharma, Inc. (COCP), Brekford Corp. (BFDI), Bimini Capital Management, Inc. (BMNM) also created outstanding short term returns.
Certain industries insider knowledge carries more weight like biotechnology. Specific examples shared, Synta Pharmaceuticals Corp. (SNTA), Accelerate Diagnostics, Inc. (AXDX),  Sequenom Inc. (SQNM) ,Conatus Pharmaceuticals Inc. (CNAT) Biotechnology created great returns.
There are many more helpful metrics to consider.


Another "anomaly" I noticed with my small 2 month data set. Combine insider buying and the review ownership, if held by value intuitions your odd may improve. So if it's held by Heartland, Royce, Kennedy Capital, Gabeli, Tenton and others as an example you may have a better chance of outperformance. But when adding to these criteria you should consider relative prior 12 month returns. Consider avoiding stocks that have had relatively large move in its stock price.


That's it for now, more insights and discoveries in future posts.


Daily insider micro cap buying will continue to be shared in the tab labeled.

In conclusion yes buying the day after reported insider purchases for micro cap value as a group appears to generate Alpha short term. But this strategy is not practical. You would have to buy all or at least a random representative sample of the population. So having said that, I would use reported insider purchases as an excellent starting point. Then review industry, size of the purchases to shares  in float,  title of buyer (Office, Director, 5% owner),  number of individual buyers, historical price performance , value ratios, who owns the shares, company size and others.


Click to view details of reported daily activity,

 

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