A Simple Hack to Beat the Big Investors for Multibagger Gains

The earnings season is here.

This quarterly ritual is much awaited by long-term and short-term investors.

As managements come live on the concalls and take questions, it's a rare chance to hear the story from the horse's mouth.

Afterall, of all the stakeholders, it is the insiders who know the most and often the first, about their businesses and its future potential.

Be it industry cycles, regulatory developments, order inflow, execution challenges, or any other positive or negative triggers in the business that could influence the business and stock performance, in the short and long term, the insiders know the best.

And yet, a lot of their comments deserve to be taken with a pinch of salt.

It's common for them to undermine challenges. Or to be over optimistic about future. The negatives are often labelled as short-term aberrations. Sometimes the short-term benefits are projected as structural trends.

It's common to see managements sharing over optimistic growth guidance or come on TV interviews highlighting all the positives.

A lot of investors act on such talk, and often end up getting disappointed when execution doesn't follow.

There are a few managements who put their money where their mouth is.

They buy the stock from open market at prevailing prices. And that's where things get interesting.

• 'Don't tell me what you think, tell me what you have in your portfolio.
  
  Do not pay attention to what people say, only to what they do, and how much of their necks they are putting on the line.' - Nassim Nicholas Taleb, Skin in the Game: Hidden Asymmetries in Daily Life

If company insiders willing to part with their personal money to buy stocks from open market, especially in bull markets like this, there is good possibility that the business is on an upward trajectory, or the stock is undervalued with healthy upside potential.

If you think about it, the chances are slim that even famous investors would know more about a company than its owners and promoters.

Yet, while there is a lot of action and talk around where big and smart investors are investing, insider buying still hasn't got its due attention.

Peter Lynch has said:

• 'Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.'

As such, tracking such insider activities could be a great starting point to narrow down the list of stocks that could be set for strong gains, among thousands of listed shares in the market.

Tracking insider activity also gives interesting insights into the prospects of the industry, well before the industry data is published and market rushes to act on it.

If there are multiple insider buying cases in a particular industry segment or sector, there are chances that the whole sector is likely to do well.

For instance, if there are multiple insider trades across companies in travel and hospitality, it's potentially a sign of the better performance in the sector and associated companies.

But let's talk of the current times. In the recent times, insider buying has been seen in the engineering segment (Kilburn Engineering, Anup Engineering, KP Green Engineering).

Considering the capex cycle and pace of infrastructure creation, it's likely that the industry is set for stellar growth.

But coming back to the main topic, all you have to do is to buy the stock at price similar or lower to promoter's average buy price, sit back, and let them do the hard work, the reward of which both you and insiders will reap.

But like everything in investing, there are some exceptions to the rule. You must keep certain things in mind to make good use of this data.

• Noise versus Signal: The promoters and the management in a business sometimes act as opportunistic short-term traders. It's not uncommon for them to indulge in entering buying and selling trades within a week's span.
  
  The key is to filter out such frequent traders (these could include employees, appointed executives) and focus on the insiders that have decent skin in the game and that are staying put with their increased stakes. Or better when they keep increasing stakes even at higher stock prices.
• Focus on 'Meaningful' Buys: The extent of insider buying could vary from a few thousands to billions. The extent of buying matters, the higher, the better. This will also depend on the overall size and valuation of the company.
  
  For a big company, a few crores would not matter much. In a smallcap company, a few crores of insider buying could imply a meaningful increase in the promoter stake. And that's where you should focus - stocks where insider buying leads to a meaningful increase in the stake.
• Procedural versus Opportunistic Buying: Sometimes, the buying activity could be driven by procedural requirements - for example, to fund ESOPs.
  
  In this case, the buying activity is to meet the ESOP guidelines and not a reflection of potential prospects of the business. Investors should focus on insider buying that leads to an increase in the stake of owners of the company.
• Never Ignore the Fundamentals: In the long term, the returns on a stock will reflect the fundamentals and the economics of the business.
  
  A discerning investor as such, should further filter the stocks with consistent insider buying on fundamental parameters.
  
  These will involve assessment of return ratios (return on capital employed, return on equity), leverage (debt to equity and interest coverage ratios), avoiding stocks with high pledging or very low liquidity, healthy cash flows and quality of earnings, corporate governance... to name a few.
  
  Basically, avoid stocks with insider buying if they do not qualify the fundamental parameters.

There are plenty of examples to support the merit in tracking insider activity.

Consider Lincoln Pharma. Lincoln pharma is a debt free smallcap company with return ratios above 15%, and zero pledge by promoters.

Since the quarter ended March 2022 until September 2023, the stock witnessed consistent insider buying.

The promoter stake in the company went up from 42.05% in March 2022 to 50.53% in September 2023. The buying price ranged from about Rs 266 in May 2022 upto Rs 523 in September 2023.

Interestingly, the promoters kept buying at higher prices, from June 2022 until February 2024. In February 2024, they executed some sell trades at a price range of Rs 713-728.

Let's say you were tracking insider activity and decided to follow their trades.

Even if you assume an entry at 5% higher price (over initial buy price of Rs 266 of prompters) and managed an exit at 5% lower than their sell price (than Rs 713), you could have made 142.3% gains in less than 2 years.

A similar pattern happened in case of Maharashtra Seamless.

The stock of Maharashtra Seamless has witnessed over 180% gains from June 2021 till date.

The promoter buying in June 2021 happened from the level of Rs 306 and continues as you read this. The latest buying happened in March 2024 at Rs 968 per share.

Sometimes, you don't even have to wait for that long. Consider High Energy Batteries (India) Ltd.

The promoters started buying the stock in November 2023 at a price of Rs 551 per share. Their latest buying from open market was in March 2024, at a price of Rs 552.

The stock has delivered around 60% gains in just five months. As I write this, it is trading at Rs 877.

In fact, I recorded a video on this.

You could subscribe to our YouTube channel here for more such interesting content.

Please note that none of the stocks mentioned here imply any view.

Like any other investing approach, this strategy does not have a 100% success ratio. There could be a few cases when you don't get the results you were expecting.

As such, using a portfolio approach and following asset allocation guidelines is critical (not more than 2% to 3% in a single stock).

With the filters in place and using discretion in insider trades, and being conscious of timely exits, you could turn the odds in your favour for market beating returns.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure