CEOs Boast of Good Results, Then Often Dump Shares
When you buy a stock after a company previews better-than-expected results, the company’s CEO might be the one selling it to you. And don’t be too surprised if the company follows it with a downbeat outlook within a few months.
The Wall Street Journal analyzed more than 1,400 instances since 2005 when a public company issued “upward guidance” -- telling the world that business is tracking better than anticipated -- and went on to release a warning that results would be weaker than planned within 120 days.
In 755 of those instances – more than half the sample – corporate insiders sold company shares between those disclosures, taking advantage of what can be an opportune time to divest shares at an attractive price.
It’s perfectly legal for executives to sell stock after guiding expectations higher, of course, and there’s no saying in most instances whether the company was in any way aware that strong results would deteriorate so quickly.
Yet, as I discuss in the attached video with Lauren Lyster, this simply underscores the way company insiders always have an information advantage, and often enjoy plenty of discretion over how to ration it out. The Journal reports that about 9% of the insiders in its study sold more stock in the “favorable window” than they had a year earlier. And 74% of them would have taken in less cash had they waited until after the negative guidance was issued.
There’s a certain irony here: One reason that a large percentage of companies provide formal guidance at all was the implementation in 2000 of the Regulation Fair Disclosure by the Securities and Exchange Commission. Aimed at thwarting the common practice of selectively disclosing market-moving corporate developments to favored analysts and investors, it required that material information be shared in a public, formal way with all investors.
Regulations aimed at leveling the playing field for smaller investors or governing corporate behavior often lead to unintended consequences.
The creation of so-called 10b5-1 insider-selling plans, which lets executives set timing and price of insider sales plans even when they possess privileged information, was meant to separate sale decisions from coming news. Yet the plans are not filed publicly and can be canceled or changed at any time without disclosure.
When Congress made executive compensation above $1 million a year non-tax-deductible in an effort to rein in CEO pay, it gave rise to the practice of paying top dogs $1 million in cash and then loading them up with company stock and options. This has actually been shown to inflate overall compensation, encourage short-term thinking and engender greater risk-taking.
Aside from cases where there is proof an executive has hidden knowledge of future poor results when selling shares, there is little a small investor can do to avoid holding the bag when an informed insider sells. One smart rule is to at least take insiders’ stock-trading patterns into account when considering buying or holding a stock.
Longtime Barron’s columnist Alan Abelson used to remind investors that there are many perfectly good reasons for an executive to sell lots of stock. They might want to diversify, or pay for kids’ college tuition, or fund a divorce. But one of those reasons tends not to be that he or she expects the stock to go up a lot very soon afterward.
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