Zacks has been collecting information on insider stock transactions since June 2007. In order to predict which stocks are likely to outperform the market, we have developed a scoring system that is based solely on our collection of insider transaction information. We all know, and many academic studies have indicated this, that company insiders may sell their company stock for a variety of reasons, but they only buy for one reason – because they know their stock is undervalued. Zacks has now proved it.

What types of transactions does Zacks use in the new Insider Rank system?

There are many types of insider stock transactions such as exercising of options or other derivatives, warrants, gifts, grants, planned sales, etc. But there is only one type of transaction that is meaningful for trading purposes – open market transactions as reported in SEC Form 4 filings. These are deliberate, often spontaneous, buys or sells of stock made by insiders that are not tied to employee compensation programs or other corporate actions. Of the two types of open market transactions, open market buys are much more meaningful than sells.

How many companies are covered?

Zacks has analyzed historical transaction details for over 9,700 active and inactive US traded stocks, and open market transactions summary data for about 7,200 US traded stocks since June 2007.

How does the Zacks Insider Rank work?

Zacks analysts have identified over a dozen factors related to open market transactions, both buys and sells, which have taken place over the most recent one to six months that can be used to predict returns over the subsequent three to six months. The factors relate to agreement in terms of the number of buy versus sell transactions, magnitude in terms of the total change in insider holdings, and transaction size.

The majority of the factors focus on open market buys, and a few focus on open market sells.   We divided the stocks into six fractal groups based on these scores. The Zacks Insider Rank is determined by which group each stock falls into. An Insider Rank of “1” corresponds to group #1. An Insider Rank of “6” corresponds to group #6. Obviously, an Insider Rank of “1” is the best and “6” is the worst.

We calculated the expected average quarterly returns (not including trading costs) attributable to each group and the average number of stocks included in each group:



Has the Zacks Insider Rank been tested in a trading model?

We ran several simple backtest studies from 6/30/2007 through 6/30/2012, using the following general parameters:

• Rebalancing Method: Equal Weighted, fully vested
• Rebalancing Frequency: Quarterly
• Universe Size: 6,025 tickers, min $0.05/share & 1,000 shares traded daily
• Benchmark: S&P 500
• Slippage, Bid/Ask Spread: None
• Trading Costs/Commissions: None
• “Strict” Buy/Sell Rules – Buy when Insider Score equals 1, Sell when Insider Score is greater than 2
• “Relaxed” Buy/Sell Rules – Buy when Insider Score less than 3, Sell when Insider Score is greater than 3

Here are the results in annualized returns:



 

 What happens if you add in the Zacks Rank?

We ran a backtest study using the same parameters as the “Relaxed” version above combined with the Zacks Rank, which is based primarily on recent earnings estimate revisions. We found that annualized performance increased by almost eight percentage points. We believe the increase in performance can be mainly attributed to the fact that the Insider Score and the Zacks Rank are powerful indicators by themselves, yet are uncorrelated to each other.   Therefore, in combination, they are more predictive than when used alone.   This makes sense because if you think about it, who knows more about the company than the executives who run it and the analysts who follow it?

Buy/Sell Rules: Buy when Insider Score <= 2 & Zacks Ranks <= 2, Sell when Insider Score >=3 or Zacks Rank >=3



How about correlations with other factors?

We ran some correlation statistics with the Insider Score and various iinvestment styles. Here’s the average monthly correlation of each with the Zacks Insider Score:

Zacks Rank:   -10%

Growth:   -16%

Momentum:   -11%

Value:   6%

The statistics show the Insider Rank is mostly uncorrelated with everything. So it would be very useful in combination with any style.

More details on the backtest results and correlation test results are available upon request.

So how do we recommend you use the Zacks Insider Rank?

The Zacks Insider Rank can be used as a standalone equity investing system, or as one of several factors used in a multifactor system. Because the number of stocks can range up to several hundred in the #1 and #2 categories at any one time, many users will want to start with the Insider Score best ranked stocks then use other factors such as market cap, Zacks Rank, or P/E ratio to filter the list of prospects down to a manageable number.

We recommend that you pick stocks ranked #1 or #2 and hold them for at least one to three months before rebalancing. We have seen good results by combining the Insider Score with the Zacks Rank #1 and #2 as shown above and with filtering results for large market caps of $1 billion or greater.

Because of the relatively low or negative correlations with factors commonly used in well known investing styles, the Zacks Insider Rank can be a useful enhancing factor in combination with many other quantitative factors. It’s kind of like shooting a little nitrous oxide into your engine combustion chamber.

Methods of Delivery:

The Zacks Insider Rank is available as a screening and backtesting parameter within ZRS 5.0 and Research Wizard research tools provided by Zacks.

The Insider Rank can also be delivered as an API in XML or JSON format, or as a raw data file in CSV format.



Performance figures referenced above are based on back-test results.

Future results cannot be guaranteed.