Tag Archives: etfs

The Recent Insider Selling Tells You Zip. Insider Buying Says Much More

In the ongoing debate about whether stocks are cheap or too expensive, the bears got some assurance from news that insider selling is on the rise. Investors often watch what insiders do because insiders are supposed to be better informed about their companies than the rest of us. So if insiders are selling, it must be because they know stocks are overvalued. Right? Not necessarily. I’m in the camp that believes stocks in general are too expensive right now. I would not be surprised to see another round of insider selling in the near future. Yet insider selling activity has no bearing on my view. On the contrary, I believe insider selling tells us very little about overvaluation. That’s because there are so many reasons why insiders might sell stock. A conviction that the stock is overvalued is only one possibility. Insiders might sell stock simply to raise cash. After all, insiders sometimes receive a relatively large proportion of their total compensation in the form of stock or options. Actual cash might make up a smaller proportion. So if these insiders want to buy a new home or send their kids to college, they might sell stock to raise cash. Insiders might also sell stock to diversify. It’s simply too risky for anyone to have all of their labor and most of their wealth tied up in just one company. It makes perfect sense for insiders to sell stock every once in a while to spread their wealth into other assets. Here’s yet one more reason why insiders might sell. Many employees are compensated at least in part with stock options. As a result, they can get hit with a tax liability when they exercise their options. They might sell some of the stock they received from exercising the options just to pay Uncle Sam. That’s not to say that a sudden spike in the amount of insider selling couldn’t be something to worry about. However, knowing that there are so many reasons why insiders might sell, I have to conclude that insider selling activity is not a useful signal of a market top. Insider buying is another story entirely. There are many reasons why insiders might sell, but there is only one major reason why insiders would buy. They buy because they believe the stock is undervalued. It’s true that a new member of the board of directors might be encouraged to buy some stock just for appearance’s sake, but that’s an exception to the rule. If insiders are using their own cash to buy stock, that a bullish signal. This just happened at one of the companies on my Bottom Line’s Money Masters recommended stock list. This company recently announced quarterly earnings that fell short of expectations. As often happens in such cases, the stock sold off in response. Yet my analysis convinced me that this stock is extremely undervalued. Apparently, several insiders agree. At least five of them purchased shares following the selloff. The CEO bought the most, spending $185,000 of his own money. That might not seem like a lot, but he didn’t acquire the stock as a result of an employee ownership plan or the exercise of options. He made a direct purchase on the open market using real cash. This CEO already owned a large stake in the company. The fact that he is willing to add to that stake should send a clear signal to other shareholders that the guy running the company is convinced the stock is cheap – so convinced that he is putting his money where his mouth is.

Valuations Are 80% Of The Stock Investing Story

By Rob Bennett I often make the claim that it is a terrible mistake for buy-and-holders not to take valuations into consideration when setting their stock allocations, because the peer-reviewed research in this field shows that valuations are the most important factor bearing on whether an investor achieves long-term investing success. I say that if you get valuations right, you are almost certain to do well in the long run even if your understanding of all other issues is poor, and that if you get them wrong, you are almost certain to do poorly in the long run even if your understanding of all other issues is strong. I sum up the point by stating that the valuations issue comprises roughly 80 percent of the stock investing story. It’s an informed estimate. I don’t believe that there is any way to say precisely how big an impact understanding valuations will have on an investor’s long-term success. But the evidence that I have seen has persuaded me that the valuations factor is of far more importance than most people realize, that it may well be 80 percent of the stock investing story or perhaps even a bit more than that. How much would you say that price matters when buying a car? It’s certainly not the only factor. You need to be sure that a car is well made. A poorly designed car is not a good deal even at a low price. And you need to be sure that the car you buy is one well suited to your needs. Someone who desires a sports car will not be happy with even a well-designed family van. And there are lots of personal considerations that need to be taken into account. Some people like red cars. Some people like black cars. Getting the color right can add a good bit to your enjoyment of the car you buy. Still, I think it can be said that researching prices and negotiating a good deal on price is 80 percent of what makes one a successful car buyer. Getting the color right is easy – you just need to be willing to drive to a second dealer if the first one you visit does not have the right color in stock. And it doesn’t take too much effort to identify the best style of car to satisfy your particular needs. We all know what is out there. You might need to check out a few vehicles to decide which particular sports car or which particular family van is right for you. But it is not difficult to get that aspect of the car buying experience settled in your favor. Nor does it take much research to learn which cars have a reputation for being built well. Getting the price right is harder. If you accept the dealer’s price, you are almost certainly going to overpay by hundreds of dollars, and quite possibly by several thousand dollars. If you do enough research to enter the dealer’s lot with confidence that you know the fair market value of the vehicle that you intend to purchase, and are willing to invest the time and energy needed to negotiate a good deal, you are going to enjoy a huge dollar return for the hours invested. You can improve your car deal by thousands of dollars by working the price aspect of the matter, potentially turning a very bad deal into a very good deal by focusing on this all-important issue. There is now 34 years of peer-reviewed research telling us that it works precisely the same way when buying stocks rather than cars. The safe withdrawal rate in 2000 was 1.6 percent real. The safe withdrawal rate in 1982 was 9 percent real. This means that a retiree with a $1 million portfolio who began her retirement in 1982 could live the life available on a $90,000 budget for her remaining years, while a retiree with a $1 million portfolio who began her retirement in 2000 could only live the life available on a $16,000 budget for her remaining years. That’s a big difference! It is critical to take valuations into consideration when planning a retirement. I think it would be fair to say the numbers show that valuations are roughly 80 percent of the retirement planning story. The story is the same for investors who are in the stage of life where they are accumulating assets, rather than living off the earnings from them. A regression analysis of the 145 years of historical data available to us shows that the most likely 10-year annualized return for stocks purchased in 1982 was 15 percent real. The most likely 10-year annualized return for stocks purchased in 2000 was a negative 1 percent real. That’s a difference of 16 percentage points of return! For 10 years running! Knowing about that difference and taking advantage of the knowledge by going with a higher stock allocation when going-forward returns are likely to be good than you go with when going-forward returns are likely to be poor turns the magic of compounding returns very much in your favor. I think it would be fair to say the numbers show that valuations are roughly 80 percent of the asset allocation story too. Lots of non-valuation factors matter. Interest rates matter. Unemployment rates matter. Consumer confidence levels matter. Inflation rates matter. And on and on. But those factors are all factored into the price that is available to the individual investor considering a stock purchase. So, while these other factors play a role in the investing game, we as individual investors need not pay attention to them. There is only one decision in our control – what percentage of our portfolio will be comprised of stocks. If we buy at good prices, we always do well in the long term. There has never once in the history of the market been an exception to this rule. And if we buy at bad prices, we always do poorly in the long run. Again, there has never been an exception. Most investors accept that valuations matter. But few realize how big a factor the valuations factor is (I can’t help but wonder if the reason might be that there is so much money to be made on the selling side by persuading investors that valuations are not a big deal). The reality is that the stock market is like every other market known to humankind – price is by far the dominant factor in the determination of whether market participants are able to achieve a good deal or not. Disclosure: None.

Don’t Be This Guy

Take a look at this picture, which I took a few years ago, on a Friday afternoon, on a New York/New Jersey ferry. After a long and stressful work week (it was 2008), the gentleman in the photo was more than a little inebriated (i.e., could barely stand up), probably the victim of an early happy hour. Now, you should also know that these ferries are fast, and the winds on the river are strong – the wind is often strong enough to blow glasses off your face. This poor soul had urgent business that was unable to wait for the trip across the river, so he walked to the front of the ferry, unzipped, and relieved himself over the bow-directly into what was probably a 35-knot headwind. Though this happened a while ago, the lesson and the aftermath made a lasting impression (probably more so on the people who did not see it coming and did not step out of the spray). Though few of us might commit the Technicolor version of this error, financial commentators do it all the time, in other ways. I spent some time this weekend doing a lot of reading – everything from social media, “big” media, gurus and pundits, and paid research. It was interesting to see the commonalities across the group (a less kind assessment might be “groupthink”), but I saw one error repeatedly: Attempts to catch or call a trend turn with no justification. This error can be hazardous to your financial health, so let me share a few thoughts. Why we are always looking for the turn I think there are good reasons why traders are always looking for the end of the trend. Many of us who do this are competitive and contrary in the extreme. I joke with people that I could have a conversation like this: Me: “Look at the pretty blue sky.” You: “Yes, that really is a pretty color of blue.” Me (now concerned because I agree with someone else): “Well… is it really blue? Isn’t it more blue green? And we know it’s essentially an optical illusion anyway…” This tendency is natural and pretty common among traders. On one hand, it’s a very good thing – you will do your own work, be naturally distrustful of outside opinions and cynical about information, and will work to think critically about everything. But it’s also a weakness because it makes us naturally inclined to see any market movement and think that the crowd is wrong. The crowd is not always wrong; often, they are right and they are right for a very long time. I think this is a simple reason why so many of us are always looking for the turn – many traders (not all) are simply wired to be contrary and to think in a contrary way. We are different, and we want to stand apart from the crowd. For many of us, this is a part of our personality and we must learn to manage it, and to understand that it is the lens that can distort everything we see. Trading lessons and psychology Beyond this element of personality, there are also some trading and market related reasons why we are always looking for a turn. There’s a misguided idea that we have to catch the turn to make money. Decades of trend following returns (for example, the Turtles) have proven that you don’t have to catch the turn; it’s enough to take a chunk out of the middle. There’s also a natural inclination to be angry and distrustful of a move we missed – if we see a long, extended, multi-month trend in which we are not participating, it’s natural to be scornful of those who did participate and to look for reasons the trend might be ending. Many classical chart patterns are taught and used out of context. Any trend will always show multiple “head and shoulders” patterns, and inexperienced chartists will not hesitate to point these out. The problem with poorly defined chart patterns (out of context) is that you can see anything you wish to see in a chart – it’s always possible to justify being long, short, or flat a market, so it’s always possible to find evidence to support whatever you want to do, at least in the absence of clearly defined trading rules and objectives. Another problem is that many traders use tools that are supposed to somehow measure extremes. Overbought/oversold indicators, sentiment indicators, ratios, bands – the problem is that these all measure the same thing, in a different way. If I get an oversold signal from sentiment, RSI, and some Fibonacci extension, I do not have three signals – I only have one because the tools are so tightly correlated. This is important to understand – if we don’t understand this (the correlation of inputs into a trading decision), then we will have false confidence in our calls, and performance will suffer. Better to know you don’t know than to think you know more than you do. Commentators and asymmetrical payoffs If a trader places a trade, she makes money if the trade is profitable and loses money if it is not. This is simple, logical, and just. However, for a commentator (blog writer, research provider, TV personality, guru, etc.), the payoffs are very different – the public remembers the times we are right, and very quickly forgets the times we are wrong. The fact there even are permabears (people who have been bearish stocks for decades) who are called to be on TV and in the paper when the market goes down is proof of this fact. It’s possible to run a newsletter or blog business for years making outrageous claims that never come true such as “end of the financial world,” “the coming crash,” “how to protect your assets from the coming seizures,” etc. The crazier and more outlandish the forecast, the better: If someone says the S&P is going down 500 points tomorrow and he’s wrong, no one will long remember because it was a dumb call. If, however the S&P should, for some reason, go down 500 points, that person is, instantly and forever, the expert who “called the crash.” In fact, if that forecast doesn’t come true but there’s some mild decline in the next few months, creative PR can still tie the forecast in. Why does this matter? You can read blogs and listen to commentators, but read with skepticism. Realize that the person writing has a reason for calling ends of trends and turns. Your trading account, however, has a different standard: If you lose more on your losing trades than you make on the sum of your winners, that’s going to be a problem, in the long run. Finding ends of trends I’ve written about this before, so I will just point you to the relevant posts. One way I have found to avoid the situation where I’m going against the trend is to require some clear signal from the market that the trend might have ended. There are specific patterns that can help: (exhaustion, climax, three pushes, failure tests, price rejection), and then seeing the change of character (new momentum in the other direction) to set up a pullback in the possibly new trend is key. (Start reading here for ideas on evaluating and catching a possible turn.) In the absence of that sequence: 1) something to break the trend and 2) new counter-trend momentum and change of character, the best bet is to not try to fade the trend and to wait for clear signals. Let me leave you with a few charts of current markets, with only one question: What direction is the trend in each of these markets? Most of the time, that’s all the commentary we need. And that guy back at the top of this post? Yeah, don’t be that guy.