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Why You Should Avoid Companies Where Founders and C-Level Execs Are Selling Their Stocks.

Updated: Apr 21

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Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.

 

Reasons why this could be red flag for long-term investors

When founders or C-level executives sell a significant amount of their company's stock, it can be a red flag for investors. Here are a few reasons why:


Daniel Schreiber, CEO of Lemonade sold almost all 2 million of his stocks within 2 months of the company's IPO
Daniel Schreiber (third from left), CEO of Lemonade sold almost all 2 million of his stocks after6 months of the company's IPO.


  • It could be a sign that the founders are losing faith in the company. If the founders, who have the most intimate knowledge of the company's business and prospects, are selling their shares, it could be a sign that they believe the company is headed for trouble.

  • It could create a vacuum in leadership. If the founders are selling a significant number of shares, it could leave a vacuum in leadership at the company. This could lead to uncertainty and instability, which could hurt the company's performance.

  • It could be a sign that the founders are cashing out before the company reaches its full potential. Founders often have a large equity stake in their companies, and selling stock can be a way for them to realize their gains. However, if the company is still in its early stages of growth, selling stock could be a sign that the founders are not confident in the company's long-term prospects.

  • It could be a sign that the founders are not committed to the company's long-term success. Founders who are selling stock may be more focused on their short-term financial gains than on the long-term success of the company. This could lead to decisions that are not in the best interests of shareholders.


Exceptions:

However, there can be exceptions when the initial founders of the companies are nearing retirement age and may choose to sell their shares to step down from their managerial roles .


Long-term investors should favor companies where the founders have high ownership of the companies, preferably 5% or more.


This is because founders with a significant stake in the company are more likely to be aligned with the interests of shareholders and make decisions that are in the best long-term interests of the company.


As of 14 November 2023, both the co-founders of Fortinet own up to 16% of the company. (source: simplywall.st)
As of 14 November 2023, both the co-founders of Fortinet own up to 16% of the company. (source: simplywall.st)


Here are some examples of companies that have performed well over the long run when founders held a lot of their stocks for a long time:

  • Facebook by Mark Zuckerberg

    • stock returned CAGR of 21% in past 11 years

  • Tesla by Elon Musk

    • stock returned CAGR of 47% in past 13 years

  • Fortinet by Ken & Michael Xie

    • stock returned CAGR of 27% in past 14 years

  • Vitrox by Chu, Jenn Weng

    • stock returned CAGR of 28% in past 17 years

  • NVIDIA by Huang, Jen-Hsun

    • stock returned CAGR of 29% in past 25 years

  • Amazon by Jeff Bezos

    • stock returned CAGR of 32% in past 27 years

  • Berkshire Hathaway by Warren Buffett

    • stock returned CAGR of 16% in past 40 years



However, it is important to note that not all founder-led companies are good investments.

It is still important to do your own research and invest in companies with strong fundamentals.



Here are some companies where their founders have sold off a significant amount of their shares upon going public:

  • Crowdstrike by Kurtz, George R.

  • Lemonade by Schreiber, Daniel Asher

  • Datadog by Pomel, Olivier & Le-Quoc, Alexis

  • Wework by Neumann Adam

  • C3.ai by Siebel, Thomas M.


Long-term investors are advised to avoid investing in these companies, to mitigate the aforementioned risks.


However, do note that there are some companies where their founders/ C-level execs sold off a significant amount of their stocks, but the stock can still generate great returns over the long-run.


For example, Palo Alto's Founder-CTO Zuk Nir, has been selling his stocks consistently over the last 10 years, yet the stock is still generating great returns for its investors.



Also, some exception can be made when the founders/ C-level execs are nearing a retirement age, and they start to sell their stock's position. As long as the successor appears to be a capable leader to take over the role.


"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise" - Peter Lynch


Where to find information on insider stock holdings:

There are a few ways to find information on insider stock holdings:

  • Use Gurufocus.com Search for the name of the respective insiders, and look for the transaction summary chart.

  • Use an AI-powered chatbot like Google Bard or Bing Chat. However, keep in mind that these chatbots are still under development and may not be completely accurate, but reliability is expected to improve overtime.

  • Refer to the company's annual or quarterly reports. The company's most recent annual or quarterly report will include information on insider stock holdings. Look under Proxy statements > Ownership of securities.



Important: there is no direct correlation of this and the stock price

Stock prices of the companies can still increase if the fundamentals of the companies are still intact although the C-level execs have been selling a lot of their holdings, as were the case with Hubspot, Microsoft & Servicenow (more on this article here).


So this is only one of the many evaluation criteria to consider when analysing a stock.



Conclusion:

When investing, it is important to be aware of the risks involved.

One way to mitigate risk is to avoid investing in companies where founders or C-level executives are selling a significant amount of their stock.

Long-term investors should favor companies where the founders have high ownership of the companies.



 

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