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How to Use Insider Trading Activity to Your Advantage to Obtain Market-Beating Results

There are many reasons behind why an insider chooses to sell shares of company stock at a given point in time, but there’s only one reason as to why they’d buy. It can be argued that an insider needs to raise cash for personal reasons, whether it’s a medical emergency or to finance some other aspect of their lives. The reasons are endless, and such insider sales are nothing for investors to worry about.

While this take on insider trading may be good enough to satisfy most investors, I’d like to consider turning this philosophy on its head.

While most insider selling activity is nothing to worry about, I believe there are many factors that may indicate that trouble may be ahead over the short to medium term. Insider trading can sometimes be of tremendous value under the right circumstances.

Some investors choose to ignore insider trading activity completely, but I believe shunning this information is a mistake. While such activities may not impact a long-term thesis, excessive selling activity may be an indicator of a potential short- to medium-term roadblock, which may result in sub-par near-term performance in a specific company’s share price.

Insiders may know important pieces of information that may not be available to the general public; thus, influential executive trading activities should not be ignored, especially if high-ranking executives are dumping a large number of shares. While it’s not an indicator of where the stock is headed, shares could have become frothy from their viewpoint, or there could be insidious factors that may gradually come into play over the coming months.

By law, insider trading activities must be disclosed; since they are, it wouldn’t technically be illegal to dump shares if an insider concludes through various factors that an upcoming quarter will likely be disappointing, sending shares lower in the near term.

Consider Alimentation Couche-Tard Inc. (TSX:ATD.B), a wonderful business that has struggled to break out over the past few years. It’s a long-term business that’s poised to enjoy high double-digit EPS growth numbers; however, the company’s latest quarter was a big letdown to many investors, causing shares to fall to the $50 level.

Late last year, founder Alain Bouchard announced his intention to dispose of 200,000 class B subordinated voting shares that he owned, along with 400,000 class B shares held by Foundation Sandra et Alain Bouchard. That’s a substantial amount of selling activity from the most influential insider out there! Bouchard’s reasons for selling range from “financial planning purposes” or “for donation commitments”; however, it really doesn’t matter, since it was a substantial amount of selling across the board.

Afterwards, another insider, Réal Plourde, co-founder and board member, announced his intention to dump 150,000 class B shares, also for “financial planning purposes”; very vague reasoning, indeed.

Could both men have foreseen the upcoming earnings miss, or is it simply a coincidence?

Fast forward a few weeks later, and Couche-Tard clocked in an abysmal quarter, plagued by short-term issues, causing shares to plunge over 6% in a single trading session before surrendering even more value in the days following.

Of course, hindsight is now 20/20, but that doesn’t change the fact that perfectly timed moves were made by two very influential insiders and could have been replicated by investors who chose to look at insider trading activities, which were publicly available for anybody who chose to look.

The selling by insiders could have actually been primarily for financing other activities and have nothing to do with forward-looking results; however, I believe closely timed and high-volume sales by influential insiders should have investors scratching their heads, especially if near-term headwinds are well known.

Bottom line

Like all investing tools, insider trading reports are a very small piece of the puzzle and are meaningless if solely relied on without support from either additional tools or evidence gathered by individual investors.

Insider trading reports, like valuation metrics (like P/E), can be abused and should not be followed blindly. Insiders don’t have a crystal ball; however, they do have the best knowledge of their business, and they’re completely aware of potential headwinds, long term and short term.

Stay hungry. Stay Foolish.

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Fool contributor Joey Frenette owns shares of ALIMENTATION COUCHE-TARD INC.  Alimentation Couche-Tard is a recommendation of Stock Advisor Canada.

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