When Insiders Talk, You Should Listen

When Insiders Talk, You Should Listen

When executives of a technology company sell off sizable portions of their company stock, they typically offer comforting words to investors.

"I'm trying to diversify my holdings," they will say. Or, "Stock options are the bulk of my compensation, and I need to free up that money." Take such words with a grain of salt.

But take such selling as a subtle warning. Perhaps what the executive should be saying is, "I know all there is to know about this company. If my confidence in the company is not high enough to hold onto this stock, why should you keep your shares?"

Such has been the case with personal computer manufacturers over the past two months.

By the time Compaq Computer Corp. of Houston said March 6 it would only break even in the first quarter instead of posting an expected $500 million profit, it was too late to react. Investors had already driven the stock down 20 percent over the previous two weeks. The day after the news hit, the stock was down another 8 percent.

Company insiders didn't suffer much from the news. Twelve Compaq officials sold 1.1 million shares in early February for as much as $36 a share, close to the company's 52-week high, according to information compiled by Disclosure Inc., the Bethesda, Md., securities research firm.

The moral of the story is that insiders know what is coming and could be telling you something with their trades.

For years, insider trading information has been used by investors as a sign of what is to come. Insiders must notify the Securities and Exchange Commission when they buy, sell or intend to sell shares. If insiders are buying, it means, "I think we will have good news to tell investors and our stock will react favorably." If insiders sell, it can mean, "I want to get my money while the value is high, because I don't expect the value to remain so high."

But, the technology industry, which popularized employee stock options as a way for shoestring start-ups to reward executives without paying competitive salaries, considers insider trading a false alarm. "This is how we get paid," tech company officials tell investors. "Insider trading doesn't signify anything in this industry."

However, Compaq is not alone. Look at others in the computer hardware field. According to Disclosure, 10 insiders at Dell Computer Corp. of Austin, Texas, sold 1.8 million shares in February. In the first two weeks of March, Dell's stock price fell 9 percent to $64 a share. Dell's executives, content with a stock price that has more than tripled in the past year, decided to take their money while the price was at a peak.

Gateway 2000 Inc. of North Sioux City, S.D., is in the same boat. Gateway's stock has risen to $45 from $25 over the past four months. In the meantime, insiders sold off more than 1.8 million shares of the stock.

Overall, insider sentiment in the computer hardware market has fallen considerably in the past six months, according to Disclosure. The research company's hardware sentiment index, which is a weighted measure of insider buying and selling, shows that more insiders were buying than selling in early September. Since then, sellers have increasingly outnumbered buyers.

"If one officer of a company sells 50,000 shares, it's no big deal," says Jim Cemprola, a research manager at Disclosure. "But if there is an industry consensus of selling, it sets off a red flag."

Bottom line: The warning signs of a softening computer hardware market have been coming over several months.

In the computer software market, Disclosure figures show insiders are selling much more than buying, but not to the same extent as in the hardware market. The same goes for the aerospace and defense market.

Semiconductor firms have just seen the tides turn in the past two weeks, as sellers are now outnumbering buyers. Insiders at telecommunications companies are still buying, but with much less enthusiasm over those same two weeks.

While there is no guarantee the other sectors will meet the hardware fate, note the possibility.