Insider Buys vs Share Buybacks

April 20, 2010 | Comments (14)

Stock Screen Strategy and Backtest Series

Insider Selling

Insiders know the company best and many people refer to the insider transactions to see whether management has been buying or selling.

When you sell shares, your reason could be a combination of any of the following:

  • The share price is too high compared to the fundamentals
  • You need to make a big payment for something
  • You need the money for an emergency
  • A better opportunity has appeared
  • To receive a tax break

Besides the first point, the reasons for selling are not related to the stock itself.

Insiders are people too, and just like us, there are times where they have to sell their stocks for personal reasons.

If an insider is dumping shares, that is a different story and you have to know why, but aside from that, I have found that it is ok to give them the benefit of the doubt.

Insider Buying

On the other hand, compare the above list to the following reason for why you would buy shares of a company.

  • You believe it is a good price and you can profit.

There are many reasons to sell, but only one for buying. Because it is cheap.

Insider Transaction Strategy and Back Test

Heavy insider buying is also the trait of a very cheap stock, which is a major theme of this value investing blog. Heavy insider buying also means that the company has run into trouble for the stock to be priced so attractively that insiders are willing to use their own cash rather than just vest with options.

Share Buybacks

Share buybacks is similar to the idea of insider buying, except, the company will authorize the repurchase of shares.

Share buybacks have the advantage of reducing the number of shares outstanding, which will increase EPS. Companies can then report higher EPS in later periods even though nothing has changed. Since Wall Street glorifies EPS, this should serve to increase the stock price.

Share repurchase plans also gives the view to the general public that management considers their company stock to be cheap enough to buy. This isn’t always the case, but the perception is true.

Another view is that the company is buying back shares because they have ample cash lying around. Repurchase programs are also announced publicly which provides greater exposure.

While insider buying leans towards cheap stocks, companies that announce share buybacks are well capitalized with operations are running smoothly. Both types of buying are shareholder friendly management, but which one will perform better?

Insider Buying Screen Criteria

  • No financial stocks
  • No ADR’s
  • Average volume greater than 20k
  • Insider buying transactions is greater than or equal to 10
  • Insider selling transaction is less than or equal to 1
  • Tried to eliminate bankrupt stocks by limiting price to be greater than $0.10

With at least 10 insider buys compared to 1 sell, I consider this is to be at the upper envelope where stocks will be extremely cheap. Extreme cheapness also equates to volatility which you may not be comfortable with, but consider this to be a starting source of ideas.

Share Buybacks Screen Criteria

  • No financial stocks
  • No ADR’s
  • Average volume greater than 20k
  • Tried to eliminate bankrupt stocks by limiting price to be greater than $0.10
  • Current shares outstanding is less than the prior TTM shares outstanding.

Insider Buys vs Share Buybacks Yearly Results

Due to the timing of this writing and the difficulty in obtaining and sorting through the data, I’ve applied the yearly dates to start from April.

2001 will be April 2001 to April 2002 etc.

Like I said, huge volatility. Even I won’t be able to handle the 70% drop. But that 465% gain in 2009 is monstrous. Refer to the graphs below to put the numbers into perspective.

Insider Buys vs Share Buybacks Screen Results

Thoughts

I expected both screens to be volatile, but not this much.

I had also expected the insider buying screen to perform the best overall, but it looks like buying back shares performs much better.

Another interesting point is that of all the screens that I’ve gone through, it seems like the down years are are sickening harsh. This is something I’ll have to think about and consider how losses could be limited.

Readers have informed me that incorporating moving averages into the screens should help to limit the downside. I’ll look into it and see whether that holds true or not.

Stocks with Share Buybacks and Heavy Insider Buys

From the list of stocks,

  • HAST [[HAST]]
  • JBSS [[JBSS]]
  • HSKA [[HSKA]]
  • DITC [[DITC]]
  • RAS [[RAS]]

have also come up in different value stock screens that I offer.

For more stock ideas, visit the share buyback screen and the insider buys screen.

Disclosure

None at the time of writing.

About Jae Jun


Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value investing tools, tutorials and educational material to help empower the individual investor. Keep in touch with Jae via any of the methods linked below.

  • Ranajit

    Jae, that’s a great comparison screen and you make a good point.

    However, I think we need to be cautious and conduct due diligence before buying stocks based on insider buys only. Like any value investor, we should also be looking at annual reports and financial statements of the company before investing.

    I remember following these two companies in 2007/2008 where there was significant insider buying. In fact, in one of them – a bank- the CEO purchased a million shares in the open market for $8/ share. I watched with incredulity, as the stocks then moved to $4 within a few months and then a year later the company filed for bankruptcy. A similar, but less ominous fate followed the other, as far as I remember.

    The point I am trying to highlight is that even though insider buying can be a sign of a stock being undervalued, we need to tread with caution. Insiders being just as human as we are can also make mistakes (probably due to confirmation bias) and reach incorrect valuations of their own companies. In fact, I think that may be one of the possible reasons why your insider buys screen underperformed the share buy back screen, although I am sure there may be other plausible reasons.

    Also, what was the size of your dateset? How many insider buys were you comparing to sharebuy backs? The larger and more comparable in size the 2 datasets, the greater the accuracy of these comparisons imho. In fact, I think the reason share buybacks underperformed the insider buys in the 2007-2010 period may be because there may have been fewer companies buying back shares in the recession (again that is my conjecture and I may not be correct)

    Btw, for your sharebuyback screen, did you use a market Cap criteria? Buybacks work better in unlocking underlying value for mid to large cap stocks than small cap stocks. It would be interesting to see how this screen would change if market cap is thrown in the mix.

    good post nevertheless.

  • zehua

    Good job, Jae. I once found a company whose insiders kept buying all the way from the 2007 top to now, when the share price has dropped 70%.
    I went through form 4 of the SEC filings, and many of these buys are from 401k. It says acquired Indirectly through 401k. I think they just set up automatic buying robot for their 401k, and then forgot it, maybe. I forgot its symbol. It is a savings and loans. I found that in the past 2 years bank insiders have been buying very actively.

  • Ranajit

    Jae, I understand the difficulty in generating these screens but I have another question about the methodology of the screens. For your screens did you assume that stocks would be purchased at the end of each quarter? What was the holding period for the stocks in each portfolio i.e did you keep the stocks for a year/2 years or more or did you choose the 20 stocks with highest buyback or insider buys each quarter and replaced them with new ones the next quarter? I think a portfolio churning it’s holdings every quarter may lose a good percentage of it’s profits to fees and short-term capital gains tax.

    Another worthwhile exercise would be if we could compare the same performance by building a portfolio of stocks( 10/20 stocks in each) by buying the stocks 1 month after the share buy back or insider buys were reported and then tracking those stocks historically for a period of 3 to 5 years. I understand building such a screen may be difficult but I was wondering if you ever thought along those lines. I am just curious to learn if investors would see any benefit by investing in stocks long after the news became public.In fact, tracking the portfolio above for longer durations may be another way to get a good feel for how share buybacks and insider buys may unlock underlying value of stocks.

    Btw, plz ignore my dataset question. I was confused by the 10 stocks on your image and thought that you had 10 or lower of each in your portfolio. Now I can see you had 20 stocks in each portfolio. Did you use 20 stocks in your portfolio during each of the periods you tested it for or did that number vary from one quarter to next?

  • zehua
  • K2

    Interesting screen as usual. I dug into one name SRT and discovered that the buyback program is meaningless. Read last sentence below…

    STOCK REPURCHASE PROGRAM
    Effective November 4, 2004, our board of directors authorized repurchases of up to $25 million of our common stock. The repurchase program will remain in effect until terminated by the board of directors, and will allow us to repurchase shares of our
    common stock from time to time on the open market, in block trades and in privately-negotiated transactions. Repurchases will be implemented by the Chief Financial Officer consistent with the guidelines adopted by the board of directors, and will depend on market conditions and other factors. Any repurchased shares will be held as treasury stock, and will be available for general corporate purposes. Any repurchases will be made in accordance with SEC rules. As of the date of this filing, no shares have been repurchased under this program.

  • Mike

    How are these backtests performed? i.e. what software is used and where is the data from?

  • http://www.fortuna-advisors.com Greg Milano

    Be cautious in buying stocks where management is buying back shares. Our research shows they do worse than companies that reinvest in the business. see http://www.fortuna-advisors.com/buybacks.html

  • zehua

    I now agree with Jae and Greg that company buybacks are not as good sign as insiders buying, especially when company buybacks are coupled with massive insider sells. It could be merely that managers are heavily compensated with stock options and awards, so they would try every way to boost the price, even in the danger of leveraging the company. When the economic hard hit comes in 2008, these high leveraged companies cannot go through the harsh weather. That is why Jae’s backtest shows such a high votility. High leveraged companies are always volitile.

  • http://www.oldschoolvalue.com Jae Jun

    All the comments here are valid because there are so many variables like mostly everything else.

    If you find a company that is dirt cheap and the company is buying back shares, as well as the insiders scooping them up, you’ve found a great start.

    On the other hand, if the company is deemed to be overvalued and share buybacks are taking place, that says a lot about management and their intentions.

    Insider buying can also be misleading but since insiders are people as well, and they are putting their money where their mouth is, I see it as far more reliable.

  • Kyle Laracey

    A fantastic back test, and a really good idea for finding potential investments. I just have two questions — 1st, how do you decide when to sell (I think someone may have already asked this)? 2nd, how do you find companies that have announced shareholder buybacks or find companies with insiders buying?

    Thanks a lot!
    Kyle L

  • http://www.oldschoolvalue.com Jae Jun

    Thanks Kyle.
    Answering your questions
    1. I sell when the price reaches intrinsic value. I don’t follow rules of selling at a 50% gain or when I’m down 20% or so. Just when it reaches intrinsic value or close.
    2. If you go to the SEC website and enter the ticker for you company, look for Form 4 which is what insiders file when buying or selling stocks.

  • Anthony

    Jae

    I have been using the insider buys screen with the following criteria. Tell me what you think.

    Altman Z Score equal to or greater than 3
    NCAV at or below 66%
    I would like to add CROIC increasing for 3 years

  • Ignacio

    Hi Jae,

    I’ve been watching the stocks of this screens for a while and found that around 50% of stocks are in both screens at the same time. Have you considered studying a new screen only with stocks that apply for both filters? If not, do you think that such a portfolio would change in any way the risk/return of the studied portfolios?

  • http://www.oldschoolvalue.com Jae Jun

    I would think that it is because companies where insiders purchase tend to buy back shares as well.
    Both screens are independent to each other though. I didn’t include any insider purchase requirements into the share buyback screen and vice versa.

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