For most retail investors, the word “insider” is often associated with insider trading and the famous scandals that come with it. At the same time, investors who try to analyze insider activity often misinterpret it, jumping to conclusions based on a cursory glance.

Understanding insider activity is crucial for grasping the whole picture behind a microcap, addressing not just the numbers but also the human element. It requires some legwork, maybe even a cold call, but in the end, it will make you a better and more successful investor.

The Basics

Complexities aside, insider activity is simply the buying and selling of stock by corporate insiders such as board members, executives, and major shareholders.

It’s a common occurrence, and it’s captured through required filings that must be made within five calendar days unless an exemption is granted, with fines applied for any that are late. There are several websites in Canada that publish SEDI filings and show insider activity. The main one is Canadian Insider, but a quick search will bring up multiple options.

When you look at these SEDI filings, you’ll see activities such as selling and buying common shares, and the granting and exercising of options, warrants, and more.

So now that you know where to view the filings, the next step is understanding them.

Insider Buying = Good

While we covered some of the basics in our 2022 article, Getting the Inside Scoop, it’s important to revisit these elements and expand on them.

First, you may recall a famous quote from Peter Lynch: “Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.

It’s as simple as that. If insider activity shows buying, it’s a good sign. It indicates that the people running the company believe in it, or at least believe it’s undervalued at the moment.

While insider buying is positive, it’s even more important to pay attention to who is buying, as not all insiders are created equal. A board member does not carry the same weight as someone with an accounting role, as their perspective tends to lean toward financial prudence.

If the CFO is buying, you should pay attention. They best understand the financial health of the company and are typically conservative with spending. Members of Legal Counsel are also key shareholders to watch, as they have a solid grasp of the company’s standing. And, of course, if the CEO is buying, it’s a good sign that leadership is putting their money where their mouth is.

If a company is doing share buybacks, generally this is also a good sign. It’s an admission by the company that its shares are undervalued.

It should be noted that insiders are sometimes convinced to buy small amounts to give the impression of strong insider conviction, and is effectively a marketing tactic. In such cases, it’s best to conduct further due diligence on the company and its management team.

Overall, insider buying is a good sign most of the time.

Insider Selling: It’s Complicated

While insider buying is a good sign, insider selling is more ambiguous.

Yes, the microcap world contains a sizeable number of bad management teams, and there are enough cases of management dumping stock to reinforce the stereotype that insider selling means retail investor fleecing. We’ve all seen this, and it’s important to acknowledge that, while unfortunate, it comes with the territory.

But while it may be tempting to conclude that the company is in trouble when you see sizable insider selling, we encourage you to hold off until you’ve followed some simple steps.

The most straightforward step you can take is to talk to the company. Find someone on the inside and ask them what is happening. Better yet, see if you can speak to the person doing the selling.

Good investing requires some difficulty, often in the form of footwork, and if you are willing to do on-the-ground research, your chance of success will be much higher. Understandably, there are often hurdles to getting through to management, as we’ve all been on the line with various IR professionals who act as the first layer of protection against public scrutiny. But even they can provide valuable context on insider activity, and a simple phone call can go a long way.

Learn to ask questions about insider activity and the financial health of the company. We have covered our criteria in several articles, including ongoing revenue and profit growth, a low share count, and healthy insider ownership. At the same time, use common sense and pay attention to what’s happening around the stock. Is it being heavily promoted and popping up on every investment site? That’s a red flag.

Better yet, follow us on YouTube and listen to the many in-depth interviews we conduct. These will give you a good idea of how to formulate questions and what to look out for.

Life Happens

If you stick to investing in stocks with solid criteria, as we do, you will often find that a conversation with management about insider selling leads to a “life happens” moment.

In the microcap world, board and management pay often comes in the form of little cash and sizeable amounts of shares. This makes sense, as a small company does not have large cash reserves to pay salaries and instead must rely on shares, warrants, and options to entice management.

When you see large chunks of insider selling, it may simply mean an insider is trying to access cash for various reasons—from regular life expenses to retirement, health issues, and more.

We have seen this happen many times. In one instance, we called a company after seeing a director consistently selling at the tops. We talked to the director only to find out his daughter had a medical condition that required quick cash. A few years later, the stock was a ten-bagger.

In another example, we witnessed what may be the most expensive car purchase in history through insider selling. In the early days of XPEL, before its legendary run to over $100+, the former VP of Sales sold for just under $1. He told us his dream was to own a Bentley, and the meteoric rise to $1 was enough to achieve this.

Life happens; people sell.

A Note on Options

Most of the time, you will see insiders exercise options, which give them the right to buy the stock at a certain price. Options are a preferred form of payment for microcaps as they can be granted to all levels of employees. They often come with a five-year window, which is a common timeframe for an employee to look for a payout.

Many times, these employees lack the cash needed to exercise options, so they will sell additional shares to do so, leading to more insider selling. This is neither good nor bad, just a neutral exchange. Importantly, employees who are not directors or officers of the company can exercise options without having to file. This may lead them to sell shares to free up cash.

It may look like undisclosed selling, but it’s just non-directors and non-officers selling to exercise options. They are cashing in on the incentive the company has given them in place of a high salary. These people may not have an investor mindset, and their activity shouldn’t be misinterpreted as a knock on the investment value of the company.

Avoid Knee-Jerk Decisions

Developing a better understanding of how to interpret insider activity will help you distinguish the good from the bad. This, combined with the other guidance we provide, will help you form an investor mindset.

With this knowledge—and a bit of digging—you will avoid the temptation to sell as a knee-jerk reaction when you see insider selling. At the same time, you will be able to jump on an opportunity when, for instance, you find the CFO of a company you follow buying a lot of stock.

Most of the time, if you are invested in a company for the right reason (it meets solid criteria), insider selling is a non-event. It is just another signal to be interpreted, and knowing how to interpret it can be the difference between a successful investment and a missed opportunity.