In this content I am presenting my personal opinion as an active private investor. This content is not intended to provide investment, financial, accounting, legal, tax or other professional advice and should not be relied upon or regarded as a substitute for such advice.
The secrets behind insider transactions and the case of Tesla
Insider information is extremely valuable for private investors. With it, they can anticipate a company’s performance before its earnings reports are released and also predict the market’s reaction, an advantage that allows for better strategic decision-making about stock positions. However, this internal insight is tightly guarded and generally only accessible to senior management or board members within the company itself (hence, the term insiders). Private investors are left to fend for themselves on the outside. There, they must make assumptions about insiders’ knowledge by analyzing their share buying and selling activity before earnings, since companies must legally disclose it when insiders buy or sell shares.
So, what are insider transactions really? Do they provide clues, or point in a given direction, about a company’s development? How can a private investor identify them from the sidelines? And can insider transactions be a useful tool for climate positive investment?
In this blog, we address all these questions and more.
In 2019, MSCI put out a study testing the power of insider trades as a predictor of stock performance. The comprehensive research looked at data from 2003 to 2019, across 50 countries and spanning more than 12,000 public companies.
The study took insider trade count, trade volume, and trade depth to get a sense of insider insights. MSCI calculated a monthly average of these three metrics and ranked the stocks accordingly. The research team then estimated the difference between the share price returns of the top 20% stocks and the bottom 20%.
Once that was done, the results were further divided between metrics for all transactions and those for filtered transactions – which excluded transactions based on automated plans, tax reasons, or stock compensation plans – to test whether this impacted the correlation between insider sentiment and stock performance.
The study yielded some fascinating insights. For all transactions, stocks with a higher insider transaction level outperformed the lower ranked stocks by 3.3% per year. And this difference went up when only taking into account the filtered transactions, rising to almost 6% annually.
Now the graph below can help illustrate the cumulative returns of both transaction groups:
The information coefficient (IC) for filtered transactions, an indicator that shows how closely the analyst’s financial forecasts – in this case, the level of insider trade activity – match actual financial results, came in at 0.54. In other words, the ranking of stocks according to insider trading proved a consistent performance predictor in 54% of the cases under study. The research demonstrates that there are indeed some meaningful insights that can be gained from closely following insider transactions.
For those who are still unconvinced and need more evidence, some additional studies have looked into this relationship between insider trading and stock performance.
- ” Insiders’ Profits, Costs of Trading, and Market Efficiency ” (1986): This study found that insider transactions do line up with subsequent returns. Additionally, the insiders with the most information (usually CEOs) are more successful predictors of future abnormal stock price changes than other lower-level insiders.
- “Are insider trades informative?” (2001): This research looked at insider trades between 1975 and 1995 and found some useful insights: (i) The market hardly reacts directly to insider trades, so the trades don’t generally trigger any direct follow-up purchases or sales. (ii) Markets performed better when insiders were bullish and worse when insiders were bearish. (iii) Arguably, insiders are a good indicator of stock returns, especially at smaller companies. (iv) The findings’ value is best applied to insider purchases, rather than insider sales.
- “Identifying Profitable Insider Transactions”(2011): This study found that the higher the level of insider conviction about the purchase (measured by the volume of transactions), the bigger the subsequent return.
- “Do Insiders Cluster Trades with Colleagues? Evidence from Daily Insider Trading”(2017): When data from 1986 to 2014 was analyzed, researchers found that, on average, when more than one insider bought sales within a two-day period, it led to a greater return than buys from a single insider.
Summing it all up
So, now we can see that there are five key takeaways from the evidence above:
- Insider transactions are a good indicator of subsequent returns; however, the timeframe of return takes place over the weeks and months following these transactions, not instantly.
- Insider buying carries more weight than insider selling. This point is particularly salient, and it can be explained relatively easily. When an investor buys sales, he or she makes an active decision from conviction about a company. Anyone who sells could also do so out of conviction, but it would more likely be a move taken because they need the money for other purposes, or because they seek to lower risk.
- The higher up in the company the insider buyer sits – and, accordingly, the more access to information she or he has – the stronger the signal.
- The bigger the insider’s buy, or the more people buying around the same time, the stronger the signal as well.
- The fewer stocks that are monitored externally, which is often the case with smaller stocks, the more meaningful the insider signals become.
The case of Tesla
Like any stock, Pure Climate Stocks aren’t immune to the effects of insider transactions. Just a week ago, it was reported that Elon Musk sold $8.5 billion worth of Tesla shares. At this point, shares in Tesla had already fallen sharply, around 20% since Musk revealed he had bought a 9.2% stake in Twitter. Shares then dropped even further when he made his takeover offer to buy the social media giant public, a decision that was accepted by Twitter’s board. The acceptance of the deal alone wiped more than $125 billion from the electric vehicle (EV) manufacturer’s stock value.
Interestingly, the second drop in share price was directly connected with insider trading. Why? Because it was the result of (accurate) speculation that Musk would sell part of his stake in the EV manufacturer, in order to fund the Twitter deal.
After the dust settled, Musk tweeted on April 29th that he had no plans to cut loose any more of his shares. The multi-billionaire – and currently the world’s richest person, with an estimated net worth of almost $250 billion – still owns more than 15% of Tesla. He also holds a more than 40% stake in the rocket company SpaceX, a company that currently has an estimated value of $100bn.
In this case, however, it’s worth noting that Musk’s stock sale shouldn’t signal his convictions about the company, nor any belief that the share price would fall – rather, it was simply due to his need for cash. It illustrates why it’s always important to view insider trades with caution, and to carefully consider any other information surrounding the transactions. Moreover, the case is also consistent with the research detailed above, highlighting the importance of looking for insights from insider buys instead of insider sales alone, such as Musk’s.
Here’s where you can find information on insider trades in Pure Climate Stocks
As the Tesla case demonstrates, only the speculation about shares being sold by a company’s CEO had a strong impact on share price. When investing in climate positive companies, it’s important to stay up to date on insider activities, since they may inform better trading decisions. Here are some Pure Climate Stocks with strong CEO ownership that could be influenced by insider buying or selling:
- Xpeng, a company that designs and manufactures smart EVs and operates an extensive network of free charging stations throughout China. CEO He Xiaopeng owns a 20% stake in the company.
- LONGi Green Energy, the supplier of 25% the world’s solar wafers (not to be confused with the cookie), which are the core building block for solar panels. Its CEO, Li Zhenguo, holds a 14% ownership stake.
- Nio, a manufacturer of high-end electric vehicles, has a share of the Chinese EV market second only to Tesla’s. Its share value has increased more than six-fold since its 2018 IPO. CEO Li Bin holds a 10% ownership stake in the company.
If you’re invested in any of these Pure Climate Stocks, or others with strong insider ownership, it’s recommended to keep a close eye on internal trading activities. One good source of information for insider trades is Open Insider.
Also, don’t forget to read our blog about the impact of strong CEO ownership on share price development!
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 Metric definitions:
Trade count: Difference of total “buy” count and “sell” count over the prior three months, divided by total “buy” and “sell” count during the same period.
Trade volume: Difference of total “buy” shares and “sell” shares over the prior three months, divided by total “buy” and “sell” shares in the same period.
Trade depth: Difference of total “buy” U.S. dollar amount and “sell” U.S. dollar amount over the prior three months, divided by the full security-market capitalization in U.S. dollars.
 A bullish insider (as well as bullish investor, or a “bull”) is someone who believes that the price of a stock will rise. On the other hand, a bearish insider (as well as a bearish investor, or a “bear”), is someone who expects the price of the stock to drop.