How to Read an Executive's Mind

Andy Obermueller's picture

Friday, October 16, 2009 - 6:07pm

by Andy Obermueller

I have a game I like to play. A little con. It generally involves two pigeons. One is a friend, the other is Bill Gates.

It never fails.

I'm always amazed at how little people know about financial information. When I show someone the SEC's site, for instance, he or she generally thinks it's special access to secret data.

It's not. I admit that looking at someone else's personal trades is a little voyeuristic, but it's certainly not secret, and the information -- available to anyone -- adds fairness to the market. After all, if the chairman of the board or the CEO is trading shares, the public has a right to know.

Which brings me back to Bill Gates.

Whenever I show someone any investing tip, like looking at insider trading, I use an example company that most people are familiar with. Microsoft (Nasdaq: MSFT) is usually a good example, especially for my little insider trading game.

You see, Bill Gates almost constantly sells Microsoft shares, and in big chunks. Well, they're big to you or me. Gates offloads a million to three million shares at a go, sometimes several times a week.

This unfailingly shocks people.

Why, they ask, would Bill Gates -- the company's founder -- be selling out of the company that made him the richest man in the world?

Why, indeed? Some draw an immediate conclusion.

"Oh, man," they say, conspiratorially. "I guess it's really going to hit the fan at Microsoft, huh?"

No. Things are fine at Microsoft.

Gates isn't selling because he thinks Microsoft is going to tank, he's selling because he owns such a vast amount of the company stock. His sales are, as I said, "big to you or me." But a million shares doesn't mean much to the richest man in the world. At last count, Gates still owned more than 700 million shares of Microsoft. He can sell a million shares a week for the next 13 years and still have more stock than you or I could ever amass.

The point of my little insider selling game is that it's critical to look at the whole picture and ask why the transaction really took place, because a significant amount of insider trading is related to executive compensation. Some executive vice president may sell 4,500 shares of XYZ Co. because that's part of his salary and he needs the cash, not because he thinks the company is a bad investment, or has hit a high. Often, these executives, even though they are selling some shares, retain significant stakes in their companies. When they do, it's reasonable to conclude that they sold their shares simply to raise cash.

Gates is an egregious example, of course. And he's not really raising cash, like most insiders are doing when they sell their shares, he's simply diversifying his wealth away from Microsoft and into cash. In $25 million chunks. It's seems like a nice problem to have.

Sometimes, however, insider sales mean more than compensation. They can be a real signal -- either someone buying on the cheap or getting out while the getting is good. These are the trades investors should watch. They are precisely why the market has the disclosure rules it does.

Consider Leonard Riggio.

He "founded" Barnes & Noble (NYSE: BKS) (a company that actually traces its roots to an Illinois printer who set up shop in 1873) and is the company's chairman. He also sits on the board of GameStop (NYSE: GME), a video-game retailer that started inside Barnes & Noble and which it spun off in 2004. As a director, he must report his GameStop trades.

On Oct. 6, Riggio sold 2.3 million shares of GameStop at roughly $26.72 a share. Now, Riggio still owns 9.1 million shares -- some 5.5% of GameStop -- but it's still worth asking why he sold 20% of his shares.

Did Riggio need $60 million in cash? Probably not. He just sold Barnes & Noble College Booksellers to Barnes & Noble for $514 million. And he draws a decent salary on top of that.

Did Riggio, like Gates, want to diversify his holdings? It's possible. But if that were the case, it stands to reason he would be selling his 31%, $370 million stake in Barnes & Noble instead.

The more likely case is that Riggio thinks GameStop, which has gained +28.5% this year, has climbed about as far as it can go. Perhaps he fears continued weakness, such as the -32.3% drop in earnings last quarter, and doesn't like the idea of holding all his shares through what could be a tough holiday season. Whatever the reason, the facts are what they are: GameStop reached a high, and a major holder took some of his chips off the table.

It does not inspire confidence in the company's immediate future.

With Gates and Riggio in mind, here's a look at a recent insider buy I ran across. A sell, after all, only tells you what to avoid.

On Oct. 8, two major owners of RegeneRx Biopharmaceuticals (AMEX: RGN) each bought 1.2 million more shares with a total market value of $2 million. In the past 24 months, insiders at this company, which is working on treatments that accelerate tissue and organ repair, have bought 11.5 million shares and sold only 625,000 shares. (And that sale, in June, was a bad move: The price has since doubled.)

The purchases, incidentally, came a few days after the company reported the progress of its research on Thymosin beta 4, which can help stop heart tissue from dying and stimulate vessel growth. The company has four other treatments in various stages of Food and Drug Administration trials, including three in the second of the three phase approval process.

Riggio, the Gamestop director, sold 20% of his shares as their price reached a six-month high. At about the same time, two insiders at RegeneRx increased their stakes by +15% after the stock had achieved a similar return.

Which one would you feel more comfortable adding to your portfolio? The one being sold, or the one being bought?

Insider trading, is, as often as not, the result of corporate officers exercising their stock options to raise cash. Sometimes, however, it's a crystal clear signal as to the likely future of the company. I think the recent moves at GameStop and RegeneRx are such signals.

Andy Obermueller does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.