Bulls on the inside

One powerful way to detect bullish "signals" in the large-cap tech area is to look for a diminution of insider selling--in other words, identify companies that have unusually low levels of insider selling relative to their historical norms.

5 min read
The large-cap summer rally has continued to sizzle--fueled by a newfound optimism for Asian recovery. Nasdaq issues essentially have failed to participate, despite the index's impressive advance. This fact is clearly illustrated by the weak breadth numbers for the Nasdaq market.

Discovering insider buying in large-cap stocks is always a challenge, because tech executives typically add shares through exercised options rather than through open market purchases. One powerful way to detect bullish "signals" in the large-cap tech area is to look for a diminution of insider selling--in other words, identify companies that have unusually low levels of insider selling relative to their historical norms. This technique is most powerful when there is a lack of selling in a high relative-strength stock, i.e., when insiders are unwilling to part with shares despite a run-up in stock price.

Sun Microsystems is a stock that fits that bill. Shares of Sun Microsystems have been performing well on a technical basis, gaining over 20 percent during the last month and breaking out of a bullish chart pattern known as a "symmetrical triangle formation." Fourteen separate insiders sold a total of 281,159 shares during the month of February, at prices ranging between $44.09 per share and $48.06 per share. Since that time, the selling has basically dried up, with only two Sun insiders having sold a total of 14,871 shares at prices ranging between $40.50 per share and $41.50 per share.

Sun insiders traditionally are regular sellers throughout the year, but the seasonal comparisons also are interesting. During July and August of 1997, company execs unloaded over 2.2 million shares at prices ranging between $37.75 and $53 a share. I don't doubt that more Sun Microsystems' insider sell filings will turn up at some point in the future, but the absence of insider selling at the company this spring and summer effectively has signaled the stock's impressive advance.

Insider selling also has lightened up at 3Com. Unlike Sun Microsystems, shares of 3Com are down roughly 50 percent from their 52-week high. The stock lately has been showing signs of life, however, heating up in late June on renewed earnings prospects. In addition, a number of analysts recently have upgraded the stock to a "strong buy."

In calendar 1997, 3Com insiders sold a total of 4.8 million shares, while, for the year to date, there have been only three insider sellers at the company, with trades totaling 1 million shares. The most recent of those sales, a 60,000 share disposition by director Jean Louis Gassée, involved stock options that were set to expire in September. The reluctance on the part of 3Com insiders to sell shares confirms the Street's optimism for the stock.

Not all positive insider clues are as subtle as those at 3Com and Sun Microsystems. In other words, there is still some old-fashioned insider buying going on in the tech sector. At the top of that list is Microsoft. Group vice president of sales and marketing Jeffrey Raikes purchased 100,000 shares in late May at $84.88 per share. In early June, the company received a favorable ruling on its pending antitrust problems, leading to a rally in Microsoft stock. The share prices has jumped 38 percent since Raikes's buy on heavy volume, and currently is trading at an all-time high.

VP of sales, CFO, and president/CEO are the three most indicative titles to watch for in insider trading in order to predict future stock performance. Not only was Raikes's buy meaningful because of his sales involvement, but his purchase also represented the first open-market buy at Microsoft in over a year.

Insiders also were buying at HCIA, a maker of medical database software products. Seven company insiders purchased 136,268 shares between May 22 and June 5, at prices ranging between $8.31 per share and $11.25 per share, marking one of the most impressive buy "clusters" in the technology area in some time. It includes the participation of both the company's CEO and CFO, and represents the first insider transactions of any kind (buy or sell) at the company since July of 1997. Shares of HCIA have a volatile trading history, dropping 30 points in October of 1996 after the company announced an expected earnings shortfall, and dropping 16 points in July of 1997 after another earnings disappointment. The company is scheduled to release earnings on July 23, and it will be interesting to see if its results support the recent show of insider confidence.

As a general rule, corporate insiders are forward-looking. Academic research shows that many of the stocks with strong insider buying do not begin to outperform until six months from the time of the insider transactions. Rational Software is a textbook example of insiders sending early signals of a potential turnaround.

The company has a somewhat checkered past. Rational stock plunged from above $22 per share to under $10 per share in October of 1997 after it issued disappointing financial results. At the time, the company's insiders were quick to step in and purchase 909,050 shares, at prices ranging between $8.95 per share and $10 per share. Since that time, Rational has been regaining its credibility with the Street, successfully integrating a number of acquisitions.

The company reported earnings on July 15 in line with the analysts' consensus estimate of 9 cents per share, pushing Rational shares to the $18 level and further indicating a successful turnaround in the stock. The company's management stated at an analyst meeting in early June that conditions were developing to warrant raised estimates later this year, and analysts appear impressed by the greater predictability of Rational's future stream of earnings.

Microsoft, HCIA, and Rational Software illustrate that software is the most bullish industry in technology from an insider trading perspective. I don't think it is any coincidence that it also been one of the best-performing segments of technology, since the group has little exposure to Asia.

Finding bullish clues from technology insiders outside of software, particularly in the large cap stocks, requires a more sophisticated approach at this time. Positive insider sentiment in stocks such as Sun Microsystems and 3Com also is tricky to spot--but is no less powerful.

Craig Columbus is vice president of ownership research for financial intelligence newsletter Disclosure. Columbus' group analyzes SEC insider filings and corporate data on behalf of institutional investor clients.