These Insider Sales Raise Red Flags

 | May 09, 2013 | 1:30 PM EDT
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For the past couple of days, we have looked at companies where insiders have been buying and whose stocks might be ready to rebound. The work of the academics and my own studies indicate a significant probability that stocks that have heavy insider buying move higher in price over the next year.

For every yin there is a yang, and the opposite has been proven true about companies where insiders are selling a lot of stock. These stocks tend to go lower over time, and investors should avoid or sell these issues. Traders should use a list of insider sales as a source of short-selling ideas, in my opinion.

It is important to differentiate between types of insider selling. One type of insider selling is not necessarily a bad sign. An executive may be diversifying for retirement, going through a divorce or other property settlement or paying for a child's education, or he or she many have any number of legitimate reasons that have nothing to do with the company's prospects. Even cluster selling in a young company may not have much meaning, as it just makes sense for newly wealthy officers and directors to ring the bell and turn some paper into cash. But when several insiders in an established company sell in a short period of time, the red flags go up, and we need to consider selling.

One stock that is seeing heavy selling is Greenbrier (GBX). The company makes railroad equipment including freight cars, hopper cars for grains, flat cars and even some marine vessels. It also provides reconditioning services and management services for fleets of railcars. The stock has been on fire of late, rising by more than 70% in the past six months. The company beat Wall Street expectations in the last quarter, as there has been strong demand for oil tank cars.

However, the rest of the business was fairly weak, and Greenbrier said it would dispose of some business units in order to raise cash. Insiders do not appear very upbeat about the near-term future, as six have them have sold blocks of stock in the past month. I find it even more troubling that both the CEO and CFO have been sellers as the stock moved to new highs. The stock has rewarded investors, but it is time to ring the register on this stock.

Constellation Brands (STZ) is another stock that has had a blistering run -- the shares more than doubled in the past year. Constellation sells liquor and wine in the U.S. and has also imported beer brands such as Corona, Corona Light and Negra Modelo. The company recently made arrangements to buy out Modelo Brewing's interest in Crown Imports as part of Modelo's deal to be acquired by Anheuser-Busch InBev (BUD). The company will need time to digest the transaction, and management has said that for the near term it will focus on paying down debt. Insiders seem to think that profits from the company are reflected in the stock price, as five of them, including the CFO, have been selling stock in the open market. You can use Constellation's products to toast your gains if you like, but it is time to take profits in this stock.

One does not usually think of an electric utility company as a growth stock, but that has been the case with OGE Energy (OGE). The company provides power as a regulated utility in Oklahoma and parts of Western Arkansas, but the exciting part of the story has been its energy midstream operations division. Earlier this year, that division announced a partnership with CenterPoint Energy (CNP) that will control more than 8,000 miles of pipeline as well as storage facilities. Investors liked the deal and have pushed the stock up by almost 30% this year.

That is a huge gain for a utility company, and insiders appear to be using the strength as a chance to cash out. In the past few months, five of them, including the CFO, have been sellers of the stock. A valuation of 20x earnings and more than twice book value is a premium valuation of this stock, and it is time to take money off the table.

Following the insiders is a two-way street. Buying signals are easier to read, as there is only one reason to buy stock. But tracking insider cluster sales in mature companies can help us avoid stocks where the business and stock-price prospects are fading or are overly valued by the stock market.

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