Insider Trends in the Financial Sector

Pop quiz: Over the past six months, one sector of the market has seen more insider buying than any other. Can you name it?

If you think it’s technology, you’d be wrong. Yes, the sector has enjoyed a resurgence in recent months, but not enough to whip up a heavy enough wave of insider buying as the sector I’m talking about.

Healthcare? It’s an excellent investment area during tough economic times, due to the essential nature of drugs and medicine that produces plenty of repeat business. But that’s not it either.

No… the answer is the financial sector. Large insider purchases have occurred at some of the following companies:

Wells Fargo (WFC) *

Bank of America (BAC) *

Wachovia Bank (WB)

Fifth Third bank (FITB)

American Express (AXP)

Genworth Financial (GNW)

Colonial National Bank (CNB)

* Market purchases by existing holders like Warren Buffett’s Berkshire Hathaway.
But for all the strong insider buying, financial shares have endured a beating.

What gives? Insider buying is one of the best market indicators. Always has been. But could all these insiders be wrong? And if they are, the question is: If the guys running these companies can be so wrong, what chance do ordinary investors have? After all, these are the people involved in the day-to-day operations and privy to details that will never be public. Are they just plain stupid? Let’s find out…

Short Versus Long

In the investment world, there are two types of investors:

Short-term: These guys look to be in and out of a stock in a matter of weeks, sometimes days. They’re looking for trading opportunities, not necessarily value.

Long-term: These investors look past the daily market noise and hype, focusing instead on the next 12-18 months for a return on their capital.

Insiders definitely tend to have a longer-term outlook. Insider buying is historically a very early indicator. For example, insiders cannot buy shares on Monday, knowing there will be good news on Friday, because they can’t trade on material information.

Instead, they buy shares on anticipation and optimism that their company is poised for future success. In addition, insiders can’t sell shares for a good length of time after buying them.

So when it comes to the current financial sector pain, the insiders who bought shares in their own companies are suffering just like regular investors.

However, here’s why you should pay attention to these trends…

Putting Their Money Where Their Mouths Are

More often than not, insider buying is a very accurate indicator – especially when a certain company’s insiders buy shares in a cluster pattern. They’re right more often than they’re wrong – and usually by a very wide margin.

You have to remember that insiders buy thousands of shares with several thousand, sometimes millions, of their own dollars. It’s not just a few hundred bucks here and there.

Ask yourself why anyone would bet the farm like this just to lose it. It may happen occasionally, but rarely when insiders buy with such gusto and such size. Such heavy buying usually signals some serious optimism.

And with the financial sector, there’s another factor at work…

A Unique Opportunity In A Mammoth Sector

In terms of financial sector shares, many insiders realize that that the current battering gives them a unique opportunity: To buy high quality stocks at very discounted levels.

This is a real “kitchen sink period” for financials – companies want to announce all their ugly losses to the market at once and get the pain over with quickly.

Financial stocks with heavy insider buying look extremely attractive now. They may look even more attractive next week. But I’d say that a year from now, they will look much less attractive from an investing standpoint.

So what’s the best way to follow the insiders?

The All-Important “Insider Window”

The key to following insider trades is timing.

If you’re looking to hop on the bandwagon with these astute folks (and remember, they know more about their companies than anyone else), you want to buy after the insiders buy.

That means you want to buy in a 3-6 month window after the insider buying has taken place. Why? Because insider buying as a forward-looking indicator is usually not confirmed by the market for a period of at least 6-9 months in the future.

You must be patient. Don’t fall into the trap that many ordinary investors do – that is, they do all the hard work by following the trends and buying shares, but then get antsy and sell at a loss within that 6-9 month period because “nothing” happened.

They then watch as the shares begin to move up in “miraculous” fashion.

But it’s not a miracle at all. It was the insider buying indicator working in time-tested fashion: Buy shares when they’re cheap and hold them until they are expensive.

Believe me, insiders also have an uncanny knack for selling at (or near) the top. Right now, they’re not selling in the financial sector; they’re buying like there is no tomorrow. We’ll check back at the end of the year to see if their strategy has worked or not. But you could do a lot worse than buying some financial sector shares now.