If you're an investor, it pays to know what the company's owners and most important shareholders are doing. By watching the trading activity of corporate insiders and large institutional investors, it's easier to get a sense of a stock's prospects. While insider or institutional ownership on its own is not necessarily a buy or sell signal, it certainly offers a handy first screen in the search for a good investment.
Below is aquick review on how you can access insider and institutional ownership information to make well-informed investment decisions.
Key Takeaways
- Insiders are a company's officers, directors, relatives, or anyone else with access to key company information before it's made available to the public.
- Form DEF 14A the proxy statement which listsdirectorsand officers, and the number of shares they each own.
- Companies file Schedules 13D and 13G to disclose outside beneficial ownership information of more than 5% of a company's stock issue.
- Stock owners file Forms 3, 4, and 5 to disclose insider beneficial ownership when they have more than 10% of voting power.
Insider Ownership
Insiders are a company's officers, directors, relatives, or anyone else with access to key company information before it's made available to the public. By paying close attention to what insiders do with company shares, savvy investors can make the reasonable assumption they know a lot more about their company's prospects than the rest of us. Since insider ownership and trading can impact share prices, the Securities and Exchange Commission (SEC) requires companies to file reports on these matters, giving investors the opportunity to have some insight into insider activity.
A trade can be legal or illegal depending on when an insider makes it—it becomes illegal if information behind the trade is not public.
The Forms
You can retrieve reporting forms from the SEC's EDGAR database or the SEC Info Insider Trading Reports. The most relevant forms that help investors review insiders include Form DEF 14A, Form 13D and 13G, as well as Forms 3, 4, and 5.
Form DEF 14A
This form is also known as the Definitive Proxy Statement. This is the proxy statement in which investors can find a list of directors and officers, along with the number of shares they each own. As an SEC requirement, publicly-traded companies must file Form DEF 14A ahead of their annual shareholders' meeting. This form also lists beneficial owners—or people or entities owning more than 5% of a company's stock—along with other pertinent information like board member nominations, as well as executive compensation.
Schedules 13D and 13G
Schedule 13D and Schedule 13G are also relevant forms to disclose outside beneficial ownership information. The following is a brief description of each form.
- Schedule 13D: This form is also known as the Beneficial Ownership Report. Anyone who owns more than 5% of a company's stock must file Form 13D with the SEC within 10 days of a stock acquisition. The form must also include the reason behind the stock acquisition—whether it's a merger, company acquisition, or takeover. Other information on this form includes the owner's identity and the source of the funds for the transaction.
- Schedule 13G: Just like Schedule 13D, this form lets the public know about anyone who owns more than 5% of a company's total stock. But it's much shorter than the 13D because it requires much less information. Owners who acquire more than 20% of a company's share must automatically file a Form 13D.
Forms 3, 4, and 5
Forms 3, 4, and 5 are filed to disclose insider beneficial ownership when shareholders have more than 10% of voting power. Forms are filed at different stages of stock acquisition.
Individuals file Form 3 when they first acquire shares. This form is also known as the Initial Statement of Beneficial Ownership of Securities. Form 3 helps the SEC track initial ownership along with whether there is any suspicious activity going on.
Form 4 is also referred to Statement of Changes in Beneficial Ownership. This form is used to report any changes of ownership of insiders who hold more than 10% of a company's stock. Part of the reporting includes the shareholder's relationship to the company.
Also known as the Annual Statement of Changes in Beneficial Ownership, Form 5 is an annual snapshot of holdings. Insider trading must be filed electronically through the EDGARsystem within two days of the transaction, giving outside investors reasonably up-to-date ownership information.
Interpreting Insider Reports
High insider ownership typically signals confidence in a company's prospects and ownership in its shares. This, in turn, gives the company's management an incentive to make the company profitable and maximize shareholder value.
But you can have too much insider ownership. When insiders gain corporate control, management may not feel responsible to shareholders and instead, to themselves. This frequently occurs at companies with multiple classes of stock, which means one class carries more voting power than another.
For example, Google's much publicized initial public offering (IPO) in the fall of 2004 was criticized for issuing a special class of super voting shares to certain company executives. Critics of the dual-class share structure contend that, should managers yield less than satisfactory results, they are less likely to be replaced because they possess 10 times the voting power of normal shareholders.
While insider buying is usually a good sign, don't be alarmed by insider selling, unless there is a lot of it. Insiders tend to buy because they have positive expectations, but they may sell for reasons independent of their expectations for the company.
Which Insiders to Watch
It's important to know which insiders to watch. Look for clusters of activity by several insiders. If a company has more than one instance of similar insider trading over a short period, there's a sign of a consensus of insider opinion. Large transactions also mean more than small trades.
Insiders with proven track records with their Form 4 activity should be watched more closely than those with little or poor past records. The most telling trading activity comes from top executives with the best insights into the company, so look for transactions by CEOs and CFOs.
Finally, be careful about placing too much stake in insider trading since the documents reporting them can be hard to interpret. A lot of Form 4 trades do not represent buying and selling that relate to future stock performance. The exercise of stock options, for instance, shows up as both a buy and a sell on Form 4 documents, so it is a dubious signal to follow.
Automatic trading is another activity that is hard to interpret.To protect themselves from lawsuits, insiders set up guidelines for buying and selling, leaving the execution to someone else. SEC Form 4 documents disclose these hands-off insider transactions, but they don't always state that the sales were scheduled far ahead of time.
Institutional Ownership
Organizations that control a lot of money—mutual funds, pension funds, or insurance companies—which buying securities are referred to as institutional investors. These entities own shares on behalf of their clients, and are generally believed to be the force behind supply and demand in the market.
The Debate Over the Implications
Whether institutional ownership in a stock is a good thing remains a matter of debate. Peter Lynch, in his best-seller One Up on Wall Street, lists the 13 characteristics of the perfect stock. One of them is this: "Institutions don't own it and the analysts don't follow it."Lynch favors stocks that the big investment groups overlook because these stocks have more of a chance of being undervalued. Lynch argues that companies whose stock is owned by institutional investors are fairly valued, if not overvalued.
William O'Neil, founder of Investor's Business Daily, on the other hand, argues that it takes a significant amount of demand to move a share price up, and the largest source of demand for stocks are institutional investors. O'Neil reckons that if a stock has no institutional owners, it's because they have already seen it and rejected it. In his book How to Make Money in Stocks,O'Neil has institutional sponsorship as the sixth characteristic to look for in stocks worth buying.
O'Neil and Lynch both agree that institutional ownership can be dangerous. These big institutions move in and out of positions in very large blocks so they cannot buy or sell holdings gracefully. If something goes wrong with a company and all its big owners sell en masse, the stock's value will plunge.
Although there are mutual funds that operate with longer-term horizons, and pension funds tend to be long-term stockholders, institutional investors tend to react to short-term events. The high correlation between high institutional ownership and stock price volatility is a fact of life in investing, and soit pays to know what the institutions are up to and whether a stock you are interested in already has a large institutional interest.
Where to FindHoldings Information
Institutional investment managers who exercise investment discretion of more than $100 million in securities must report their holdings on Form 13F with the SEC. This form is filed quarterly by institutional investment managers who have a minimum of $100 million in assets under management (AUM) within 45 days of the end of a quarter. Again, you can search for and retrieve Form 13F filings using the SEC's EDGAR database. Yahoo Finance also provides a very useful site that details stock ownership. Get a quote of a particular company, and then click the section labeled "Holders"to receive details on the company's institutional holders.
The Bottom Line
Sure, insiders and institutions tend to be smart, diligent and sophisticated investors, so their ownership is a good criterion for a first screen in your research or a reliable confirmation of your analysis of a stock. But never base an investment decision solely on insider or institutional ownership information.
