Important signals: why smart investors study director deals
You’ve opened your investment account, mastered the mechanics of buying stocks and familiarised yourself with the main catalysts that move share prices. Now the first-time investor needs to add additional weapons to their stock picking armoury.
Among the signals that indicate whether a company is thriving or diving are director dealings, where a company director either buys or sells shares in their own employer.
A chief executive, chairman or finance director should know everything that’s going on in a business because they see the sales figures, monitor its costs and see various key performance indicators. Typically, they will be involved in strategy meetings and know if a company is achieving its objectives or not.
SENDING POWERFUL SIGNALS
Business leaders know the state of their businesses better than anyone, or at least the good ones do, so when a chief executive invests their hard-earned cash into a company the first-time investor should certainly sit up and take notice.
Though non-executive directors aren’t involved in the day to day running of a business, they will certainly be involved in board meetings, meaning that they boast valuable insights into a company and their trades are also worth following.
Conversely, a significant share sale can indicate something is amiss, with a downswing in fortunes and the share price potentially on the cards, or that the director feels the share price is too high and riding for a fall. However, share disposals can be less reliable indicator than share purchases, as we’ll explain later in this article.
DO YOUR DUE DILIGENCE
It is important to stress that director share buying and selling isn’t a signal for other investors to blindly copy them. Instead you should consider their actions as part of deeper research into a business.
First-time investors should also be aware that directors can only buy or sell at certain times of the year. They cannot deal in a closed period which is when financial accounts are being prepared. They also cannot buy or sell if there is undisclosed inside information, such as news of a possible takeover or a major contract win or loss.
Directors’ buys and sells must be reported to the stock market. so it is easy to find out who is doing what.
How to find the details
Investors should scrutinise the daily stock market announcements that are headed ‘Director/PDMR Shareholding’, then scroll down to the ‘Nature of the transaction’ heading. Here you will find out whether the shares being acquired or disposed were via dealings in the open market or relate to the exercise of share options and subsequent sale of these shares.
Unfortunately, most directors do not disclose the reasons behind their share purchases or disposals apart from meeting tax liabilities.
The significance of share deals in relation to the number of shares held by a director is always relevant. For example, a purchase of 20,000 shares by a chairman who owns more than a million shares may not be that important. However, the finance director doubling their holding of 20,000 shares is a very different matter. In a similar way, the sales director selling 20,000 shares out of a holding of 25,000 would not be a good sign.
And finally, be alert to whether directors are buying shares just to give the impression everything is fine when it might not be. Sometimes when companies are known to be in trouble, a cluster of directors buy a few shares to try to reassure the market that all is well.
PUTTING MONEY WHERE THEIR MOUTH IS
A director buying stock after a big rally in the share price, or investing in the shares after joining the board, sends a strong signal to the market that the person is very confident about a company’s prospects.
For instance John Roberts, chief executive of online electricals retailer AO World (AO.), in July 2020 increased his beneficial interest in the Bolton-headquartered retailer to 22.76% through a pair of trades (one a purchase by his wife) following the company’s full-year results. The fact he bought after the shares had already seen a large rally would suggest he is very bullish about the company’s prospects.
Equally someone selling after a slump in the share price doesn’t show much faith in a company’s position, although these situations are not always black and white.
Some directors buy stock for a perfectly logical reason. For example, a new chief executive of a FTSE 100 company often has a clause in their employment contract that they must buy a certain value of shares to align their interests with shareholders.
Directors can sell stock for personal reasons which have no reflection on the state of their employer; they might need to free up funds for a divorce or raise money to pay for someone in their family to have medical care. You also quite often see directors sell some shares when they’ve received stock as part of a bonus payment, where they are selling to raise enough money to pay the associated tax bill.