Insider stock trades and the concept of ‘Ma’

One of the most intriguing things (to me at least) about Japanese art is the concept of ‘Ma’ (間). Ma denotes the space between things or the ‘gap’ (though that is really an incomplete translation). In Japanese art, this gap is typically considered an ‘object’ in itself and just as important as the things present in a work of art. Take the picture below. The empty spaces around and between the pine trees are considered as important as the trees themselves.

Pine Trees by Hasegawa Tohaku

Source: Wikimedia Commons

I would like to believe that this concept of Ma is what inspired Luke DeVault and his colleagues to look at the stocks sold and bought by corporate insiders – or rather the stocks not bought and not sold by them.

They realised that many directors are sitting on the boards of more than one company and when they sell or buy stocks of these companies they are making a decision which ones to sell and which not to sell. We know there is some information in insiders buying stocks. If a corporate insider buys stocks of his or her company, this is usually followed by an increase in the share price. On the other hand, selling shares in that company doesn’t provide a reliable signal. This is particularly the case if a corporate insider sells shares due to liquidity needs, e.g. to pay taxes on shares and options received in the past. Such “forced sales” have no forecasting power for the share price.

But what if the corporate insider is also an insider in another company or several other companies? Then the insider can choose to sell stocks of company A, B, or C to settle a tax bill or create liquidity for other purposes. DeVault and his colleagues showed that corporate insiders use their insider information to select the stocks to sell that have the worst outlook. And they are so good at it, that by investing in stocks that these company insiders choose not to sell one can outperform the market by up to 4.9% per year before transaction costs. What’s more, after transaction costs the outperformance persists but declines to 2.3% per year when stocks are adjusted monthly. By reducing the trading activity and holding stocks for a year the outperformance after costs is much higher at 4.8%. That is a large effect though one has to be aware that the number of stocks ‘not sold’ by insiders is probably not too big, so the resulting portfolios are likely to be highly concentrated. But the point is clear. Look not at what corporate insiders sell, but what they choose not to sell. That’s the stuff you want to buy.

Performance of stocks not sold by corporate investors

Source: DeVault et al. (2021)