Peter Hodson: Insider selling is not that important and target prices are almost useless

We all know school is out for the summer, but that doesn’t mean you can’t still learn something. After all, those nerds going to summer school often get ahead of the crowd.

So, let’s dig into some more investment lessons, or rules, that we like to follow in the stock market. They are not perfect, but they have worked well for us over the past 40 years. We break them or ignore their guidance once in a while, but we usually end up regretting that decision.

Insider selling is not that important

Insider buying is very important. There is usually only one reason for an insider to buy shares in their own company: they want to make money. Insider buying is a key sign that investors should look for. But selling? That’s a different rule. There are dozens, even hundreds, of reasons why an insider might sell their shares. They need to disclose the transaction, but there is no need for them to report why they are selling.

Let’s take a recent example. ADF Group Inc. is a structural steel company listed on the Toronto Stock Exchange. In June, insiders sold $48-million worth of stock, which caused a lot of concern amongst investors. But there are two offsets to this concern.

First, it was the company that bought the insiders’ shares (to be cancelled). The company was clearly comfortable buying them. Second, the stock is up 252 per cent in the past year. Even with what was a large sale, the stock price gain means insiders still have more actual money at risk than they did last year. In other words, this sale shouldn’t have caused investors to panic.

Target prices are almost useless

We know that stock analysts are smart people. Most are brilliant. But they are also salespeople, followers and conservative.

Analysts do not like sticking their necks out, so typical target prices are grouped around a very tight price range. If an analyst is an outlier, they look very bad when they are wrong, so they change their target to be more in line with their peers. This makes them conservative.

They are followers in that, as we are sure you have seen at times, they tend to raise a stock’s target price after some good news or lower the target price after bad news. Essentially, like you and I, they cannot predict the market, so why look at their target prices?

Often, a downgrade in the target price can be a buying signal since it highlights how analysts are fed up with that particular company.

Any stock can fall 50% — overnight

This manta is great for us when we have a winning position and we let greed sink into our thinking. Suppose we have a three per cent stock position and it triples. Yippee, good for us. But if our other stocks don’t do well, we now have a nine per cent position in our winning stock.

Sure, we like to let winners run, but we remind ourselves that any equity can go down, sometimes by a lot. We don’t care if it is a bank, a giant conservative company, a tech company changing the world, or whatever — it can go down.

If we are lucky or smart enough to own a big winner, we ask ourselves how we would feel if our entire portfolio fell 4.5 per cent overnight (a 50 per cent decline of a nine per cent position). Generally, we would cry. This brings us back to the prudent management of position sizes. In such a scenario, we might take the nine per cent position and trim it to seven per cent. If we really like it and it does well, it is going to go back to nine per cent anyway.

Daily prices are not worth paying much attention to

We know investors — not traders — who check their stock prices hourly or even more often. Our company often gets questions along the lines of, “Why is this stock down two per cent today?” Nine times out of 10, we don’t know the answer. If there is no news, broker activity or macro event, then there is usually no defined reason for a stock to move, either up or down.

With no news, it might mean something, but you and I have no way of knowing if it does, and any speculation is just that — a guess. We like trends, certainly, but one day is not a trend. The time that investors spend looking at meaningless daily price movements could likely be better spent doing some research.

Now, if you intend to sell a stock, then yes, daily moves are more important. But if you are a long-term investor, constant price checks are a waste of time, most of the time.

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Company executives are salespeople

Here’s a fun fact: We have never — and we mean never — seen a company presentation that outlined how horrible things are at that company. Generally, if things are bad, a company will not bother going on an investor road show. Nope, company presentations all show “opportunities” and “growth” and how their company is “undervalued” and “better positioned” than their peers.

Honestly, it is like a meeting with the rose-coloured-glasses club at times. Every stock should be bought, and you, the audience, are idiots for not buying it, they say. It gets a bit much and the meetings become less useful. The information presented can still be good, but it is important to always remember who the presenters are. In addition to running a company, a CEO’s job is very much that of a stock promoter.

Take Care,