How To Identify Short Candidates Through Anomalous Insider Selling Activity

Perhaps the most reliable shortcut to identifying a company at elevated risk of a downturn in its share price is looking at how executives and directors use their equity instruments. This might sound too simple to be predictive – something that would be quickly understood by the market and integrated into investors’ thinking on a scale that would cause the “edge” to disappear. But there are complications that have prevented that from happening, on which I will elaborate shortly. But first, let’s look at some recent examples.

Over the past two years, Gradient Analytics has published five brief “snapshot” reports based on our Equity Incentive Analytics examining signs of unusual and concerning equity use by executives and directors. The subject companies were Amarin (AMRN), United States Cellular (USM), WW International (WW, or WTW when we wrote on it), Supernus Pharma (SUPN), and Magellan Health (MGLN). All five of the reports preceded significant declines in company share price, with four of the five stocks showing double-digit declines over the ensuing three months and all of them hitting double-digit declines over six months. Read on....

The average 3-month/6-month/max drawdown returns were -18.6%/-32.4%/-38.5%. Relative outperformance (versus the benchmark S&P 500) was even better, at -19.5% over three months and -37.4% over six months.

Gradient insider selling examples

And what’s more, these were companies that were not widely shorted, with an average short interest of only 7.5% at the time of our reports (ranging between 1.9% to 14.0%). If we look a bit further back to three years or so, Gradient also wrote on OraSure Technologies (OSUR) on 06/09/17, which painfully went against our short thesis for about seven months before hitting an inflection point and ultimately falling well below our initiation price by late 2018, and MYR Group (MYRG) on 12/02/16, which was down -22.7% six months after our initiation (and -34.0% relative to the S&P 500).

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Disclosure: At the time of this writing, the author held no positions in the securities mentioned.

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