How You Can Benefit From the #1 Worry of Public Companies
Keep an eye on what management is doing
Being the CEO of a public company is the worst job in the world.
You must put on a radiant smile even if pessimism is the word of the year. One wrong remark at an earnings call and your company’s stock plummets 20%.
I can tell you what’s on CEOs’ minds all the time. This main worry of any public company may shock you.
But it’s dead obvious.
How to benefit from valuation
Can you imagine someone taking over Apple?
I can’t. It has little to do with the iPhone or the entire Apple ecosystem. Apple’s valuation is key.
It’s all about the company’s stock price. It’s like its heartbeat - strong and steady means health, weak and unstable means trouble.
The company is seen as prospering if the stock price is high. Make it too low and get ready for a hostile takeover.
Apple’s market cap - number of shares × share price - is $3,3 trillion. A towering fortress. Not even Elon can scrape together more than 5% of the giant’s valuation.
The iPhone manufacturer has a great public image. It innovates and markets its products. Your iPhone feels great in your hand.
If you hold Apple stock, you’re confident you can preserve your wealth. So you’re not selling, which stabilizes the stock price.
Your support means Apple can raise capital in two main ways:
Diluting existing shareholders by issuing more stock. The higher the stock price, the less the dilution.
Borrowing money. The higher the stock price, the less risky the debt, the less the interest.
With a high stock price, Apple’s shares are golden tickets for acquiring other companies. Public companies don’t always pay cash. They can pay in stock for smaller businesses.
And because nobody can afford to buy Apple for $3,3 trillion, the high stock price is also a takeover defense.
Getting compensated via Apple stock is another perk. I wouldn’t mind a few shares landing in my brokerage account if I worked for the company. It’s cool and they pay dividends. Stock-based compensation is a traditional method of paying management.
A high stock price is a magnet for top talent and a joy for shareholders. Nobody wants stocks to fall except for short sellers (and they’re often wrong).
The management of a public company rides the same roller-coaster in the stock market as you. Their fortunes are tied to the stock price. They have the most interest in making it climb.
They’re also the people who have the most control over it. It’s not absolute control. The market tends to have its own opinion. But all major decisions come from management.
So you better keep an eye on what insiders do.
Red flags and green flags
Journalist Jason Zweig wrote in a commentary on The Intelligent Investor:
“Management sells stock to settle a divorce, buy a larger house, or dump it because the company’s profits are about to fall. But it buys stock with one idea in mind: Expecting it to appreciate.”
Insiders must file their transactions with the Securities and Exchange Commission. The public company they’re managing doesn’t belong to them. It belongs to the shareholders. As a shareholder, you have the right to know what management is up to.
Go to www.nasdaq.com -> Market Activity -> Stocks -> [Enter a stock ticker] -> Insider Activity.
It’s a good starting point to evaluate insiders’ perspective on the company.
Insider selling is a huge red flag. I love Peloton’s fancy exercise bikes. But I’m happy I didn’t buy the stock in the fall of 2020 when management was dumping it near the all-time high.
I’d rather go with Uber. Its CEO Dara Khosrowshahi made headlines in May 2023 when he bought 200k shares. That many shares are worth $5,3 million. Surely Mr. Khosrowshahi knew what he was doing?
It may be harder to figure out what’s behind the insider activity of older companies. They’ve been around for so long it’s unlikely for a few board officers to have a large stake.
Institutional investors hold most of the General Motors stock (93%), followed by retail (7%). Although insiders have recently sold more than a million shares, it’s a tiny number relative to the total shares outstanding. The stock is on the rise in 2024.
Insider trading is one of the many factors to consider when analyzing public companies. Check what institutional investors - true trillion-dollar investors - are doing with your target stock. Make sure the company is growing its revenue and earnings.
And keep in mind everyone wants the stock price to grow.
The bottom line
Insider buying isn’t a guarantee your stock will soar. But it ensures management aligns its interests with yours.
It makes zero sense to buy a stock when management is selling it. If you ever decide to invest in a public company, check the latest insider transactions.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
Management buying is not always a good sign, although I think it most often is. Sometimes, a CEO or Board member steps up when they believe the share price has been under unfair attack and they want to send a message. They can afford to lose what they invest, and are counting on the public not looking into the details.
Similarly, a sale is not always a sign of bad news. Because equity compensation is by far the largest component of most senior managers' pay, all but the independently wealthy need to sell shares from time to time.
If it's a company one follows, a careful investor can usually read enough between the lines to figure out when buying means good things (or not) and when selling means bad things (or not)