Should you really bother with director dealings as a basis for investment?
As the tech boom was reaching its giddy zenith exactly a decade ago, I advised a director friend of a company benefitting from the mania to sell all his shares and head for the sun.
He reckoned he simply couldn't as there was a great deal of pressure on him from everyone connected with the company not to sell the shares as it sent the wrong message to the market at a crucial time. I think the shares were trading on a forward price-to-earnings ratio of around 46,000 at the time.
OK, I'm exaggerating a little; they were heavily loss-making and going through investors' cash like a hot knife through butter. But the shares were trading around 170p if memory serves. Two years later, they went to a low of around 3p before eventually getting taken over.
Devil take the hindmost
So what? Well if the individual concerned had been a little less polite and stronger willed, he'd never have had to work again. And you'll have to take my word for it that he's atypical as far as most listed company directors go. In other words, most others I've come across would have said: "Sell and the Devil may take the hindmost" -- or something to that effect.
And that would, indeed, have waved a big red flag to investors, though to be honest it probably wouldn't have been listened to given the madness of the time. Also, any sell would have been dressed up in some way; "early retirement ... family reasons ... a tax bill ... house purchase ... nothing to do with business..." etc to allay investors' fears. And those reasons would have been real. But they'd still have been worth listening to. After all, if you truly "knew" that shares were going to do well, you wouldn't sell unless it was a dire emergency.
Voting with their feet
And that's the point, of course; people vote with their feet, whatever the reason. We've heard it all before about the importance of watching directors' dealings and it's all a bit boring. But put yourself in a director's shoes and think about how and why you'd buy or sell shares in your own company for a moment and then let it inform your decision.
Like it or not, you have to take into account directors' deals and to allow them to inform your decisions one way or another -- whatever the seeming reasons for them are. More usually, the deals are trumpeted the other way; a director buys and it's greeted with euphoria by private investors, particularly in the flavour-of-the-month hot stocks. Yet some of these deals are relatively trifling and there, the cynic might think, to add a little petrol to the flames.
Beware the accepted logic
The accepted logic has it that directors should know their business and their market better than anyone else. There's a lot of truth in this. But then the directors often don't know the wider market, have an over-inflated sense of their company's importance in the wider world and are often unduly optimistic about its prospects. Directors almost always see their companies as undervalued / ignored by the market -- but how much of their own new cash are they really putting at risk? All these factors need to be taken into account. And it's not easy.
Nevertheless, the figures seem to speak for themselves. Research from directorsdeals.com shows that shares bought by directors "significantly outperform when they meet certain parameters" according to Director, Michael Tindale, for example, where a number of directors are buying at the same time, or there are significant changes in holding.
Won't deal or can't deal
Remember that 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 there could several months of the year when directors can't buy or sell shares.
In the end, it's a matter of walking a mile in the director's shoes. If s/he is dealing, ask yourself why this is, how significant it is, what his/her track record in dealing is, how long in the tooth they are and, ultimately, how likely to be right they are.
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