Do Insider Purchases Outperform the S&P 500?

A wide body of research suggests that insider purchases outperform the market. In one study out of Harvard and Yale, insider purchases beat market returns by 11.2% points per year or 8.5% points on a risk-adjusted basis. Another report showed insider purchases outperforming by 25-36% points depending on the hold period.

But why trust others? We wanted to do the research ourselves.

We collected stock price data from Google Finance and insider transaction data from app.stockocean.com. We found 2,741 transactions using the following criteria.

• Open market purchase between 12/20/2021 and 12/20/2023

• Transaction size between $100K to $1 million

• Company Officers Only (CEO, CFO, VPs, etc.)

Open Market Purchase

We focused only on open market purchases and ignored any grants, gifts, or purchases due to options expirations. An open market purchase by an insider signals confidence in the stock. The same can’t be said of other transactions, because those are largely out of the insider’s control.

Prior studies on insider trading often analyzed transactions during bull markets. We did the opposite and focused on the last two years from December 2021 to December 2023, which have been unusually volatile.

Transaction size between $100K to $1 million

We decided to focus on transaction sizes that signaled confidence which we believed to be at least $100K. We capped the transaction size at $1 million. Anything greater has the potential to move the stock price by the trade itself. Large transactions also invite press and scrutiny which influence the stock price.

Company Officers Only (CEO, CFO, VPs, etc.)

We focused on company officers, who we think have the greatest insight into their company. We ignored 10%+ owners and board directors; board directors usually meet once a quarter and 10% owners can include hedge funds and investment firms which are outside the scope of this analysis.

Analysis

To run our analysis, we gathered data on when company officers purchased stock, and calculated the stock price change one week, one month, three months, six months, and one year later to see their performance over time. We then benchmarked returns and losses against the S&P 500 across the same dates.

For example:

1. CEO A purchases stock on January 1st, 2023 at $10. The stock price is $20 one week later. He has a 100% return in one week.

2. S&P 500 has a price of $4,000 on January 1st, 2023. S&P 500 moves to $6,000 one week later. S&P 500 has a 50% return in one week.

3. The alpha (excess return) from CEO A’s transaction is 50% (100% stock return minus 50% S&P 500 return).

We ran this analysis across each of the 2,741 transactions and took the average return across each individual time frame.

Caveats

• Our analysis assumes equal weighting across each stock.

• 2021 to 2023 was a unique time in the market.

• Companies that were delisted or acquired were excluded due to difficulty pulling historical stock data.

• We assume the company officer is holding the stock through each set time period.

• We do not recommend replicating these trades because the market is dynamic and past performance is not indicative of future performance

Results

The results shown below are not risk-adjusted so potential profits and losses may be amplified.

Overall, insider purchases returned on average 3.7 percentage points over the S&P 500 over a one week period and 2.5 percentage points over one month and three month periods. However, at six months and one year, insiders’ returns fall below the S&P 500 by 2 percentage points and 6.5 percentage points, respectively.

Our analysis suggests that insiders make better short-term stock picks, but underperform the market over longer time periods (six months to one year).

Possible explanations:

• Company officers have a short-term mindset. It’s easier to imagine an upcoming event within three months than 12 months.

• Institutional and retail traders track company officers’ trades and use it as signal to buy, driving up the price.

In addition, we cut the data across various parameters including officer title, size of trade, and timing. Here are a few of the most interesting segments of the data above:

$200K-$300K Insider Buy vs. S&P 500

Based on the data, if company officers purchased between $200K-$300K in stock, they outperformed the market by at least 3 percentage points over any time period, even six months and one year.

Possible explanations

• $200K-$300K is the sweet spot for “smart” company officers: the trade is substantial but not too large to set off alarm bells.

• Company officers who make purchases between $200K-$300K are more likely to repeat purchase, signaling further confidence in the company; company officers who make larger purchases are more likely to purchase only once.

Chief Medical Officer Buy vs. S&P 500

The segment with the greatest short-term alpha are Chief Medical Officers (CMOs) buys. CMO buys outperformed the S&P 500 by almost 17 percentage points over one week, 12 percentage points over one month, and 14 percentage points over three months. However, after one year, the average stock price plummeted by over 45% on average.

Possible explanations:

• CMOs have unique insights into drug approvals or drug effectiveness, which lead to outsized returns.

• The drop off after one year shows the volatility of healthcare and pharmaceutical stocks.

• The sample size is small - only eight CMO purchases - so every insider buy has a significant impact on the average.

Conclusion

Based on this analysis, there is short-term alpha generated by company officers, but it only lasts for three months. Make friends with doctors, but for no longer than a year.

Kidding aside, there are many ways to cut the data to find specific segments of alpha. If there is a specific segment you’d like to see, respond to this e-mail and let us know.

As mentioned before, we do not recommend blindly copying insider trades. Instead, we suggest using insider buying and selling as a complement to your research or a starting point for further investigation.

As always, do your own research; this is not financial advice.