That may be true, but taking the strategy one step further can tilt the odds even more in investors’ favor.
New research by University of Kansas School of Business professors Kissan Joseph and Jide Wintoki indicate that investors will do even better by limiting these tactics to companies that use significant amounts of advertising. Those insiders did much better than insiders at firms that don’t advertise.
The bottom line: insiders’ knowledge of a company’s advertising expenditures is a strong information advantage when it comes to trading. These findings appear in a paper, “Advertising Investments, Information Asymmetry, and Insider Gains,” which will appear in the upcoming issue of the Journal of Empirical Finance.
According to the research, between 2004 and 2008, aggregate advertising expenditure for all firms in the Compustat database was twice as large as R&D expenditure, which has been a source of information on insiders’ investments.
The authors analyzed publically available advertising and transaction data from more than 12,000 firms between 1986 and 2011; they concluded that insider gains are significantly greater at firms that are making advertising investments. A zero-cost portfolio that was long on advertisers with net insider purchases while taking short positions on non-advertisers with net insider purchases would have produced annual abnormal (higher than expected) returns of 5.5 %. As Wintoki pointed out, that annualized 5.5% is a significant amount.
The authors also found impressive results for investors who reacted quickly to news of insider buying at advertisers. According to Wintoki, in the first three days after disclosure of insider purchases at companies that advertise, those stock prices rose by 0.3 percent more than those in non-advertisers where insiders bought company shares. That’s equivalent to a 27% annualized return.
Such results do not depend on the level of advertising. Even if one company spends twice as much on advertising as another, its insiders will not necessarily post twice the returns from trades in company stock. As long as both companies spend a non-trivial amount on advertising, insiders at both firms are likely to have higher-than-average gains.
“If your investment strategy includes mimicking insiders, paying close attention to insiders at advertising firms may improve the profitability of that strategy," Wintoki said.