When do you really need to look closely at directors' dealings as a basis for investment?
If there are as many bargains around the stock market at the moment as some of the more excitable bulletin board posters seem to suggest, then why aren't directors filling their boots with their own shares?
This is a vital question that all private investors should be asking themselves, in my opinion, particularly with small caps. And the smaller the cap -- the more relevant the question.
OK, there are manifold reasons why directors may not wish to buy shares in a perfectly well-run company with excellent prospects of which they happen to be on the Board.
But there are far more reasons to buy the company's shares -- and if they aren't, and never have been very significantly in the past, you have to ask yourself why that is.
Do they need to buy?
The first thing to do is to go straight to the company's annual report and have a look at directors' remuneration details.
If the salaries and emoluments -- and maybe free shares -- being allotted to directors aren't exactly in keeping with the overall valuation and performance of the company, then you have your answer and the potential investment should be filed without further ado in the appropriate place!
On the other hand, when directors really fill their boots, the effect on the share price can be quite marked. I'm not talking about short term movements here, by the way. Of course, a major director purchase can move the price in the short term, but once the dust settles, the longer term price movement can also be stellar.
Owain Bennallack pointed out how directors of AIM-listed diamond miner Petra Diamonds (LSE: PDL) had spent a collective million quid on their shares almost two years ago at 22p. Today, the shares are 187p.
Similarly, another big winner was Volex (LSE: VLX). I noticed in April 2009 that:
"The directors have shown some confidence, buying a reasonable amount of shares recently around 24p".
I bet they wish they'd had even more confidence. The shares reached 380p last week.
It's not that easy
If only this investing life was that easy. Very often, directors are some of the least objective people you're ever likely to meet about their own company's prospects. With their heads understandably down in the detail of doing their jobs, they can fail to see the wider picture and how their company and its prospects are regarded by world-weary cynical investors.
In other words, they can get it wrong.
So you can't trust director buying as a sure-fire way of making a return -- even in the smallest of small caps. But you certainly can question why it hasn't been happening in a company where everything else seems so positive.
Can't deal -- or won't deal?
Under UK stock exchange rules, directors can't buy or sell shares when they're in a 'closed period'. This is the shorter of two months before half-year or annual results are issued and the time between the end of the accounting period and the day the results are released. If a company issues quarterly results, then it's just one month.
Directors also can't deal if they're in possession of information that might move the share price if it was made public -- a profit warning or major new contract, for example. So in practice there can be several months of the year when directors can't buy or sell shares.
Research from directorsdeals.com shows that shares bought by directors "significantly outperform when they meet certain parameters" according to its Director, Michael Tindale.
An example of positive parameters would be where a number of directors are buying at the same time, or where there are very significant changes in holdings.
The latest data from Directors Deals reveals buys outstripping sells by a ratio of roughly around 2.5:1 in numbers of transactions over the last few months, whilst in money terms sales outstrip buys by roughly 4:1, which looks to be somewhere around the long term average.
This is explained by the fact that directors tend to buy steadily and sell in one-off large amounts on the whole.
More tellingly, the data show directors buying more heavily when the market falls.
In the end, you need to take directors' dealings into account as part of your overall analysis -- asking "why now?" and how significant the deal is at this time, and, ultimately, how likely they are to be right.
Whatever you do, don't ignore them, particularly with small caps.
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