Looking behind directors’ share deals

It’s often assumed that when directors buy or sell their company shares, they must know something that we don’t. But how true is that? And is the timing of their deals significant?

The rule is simple: if you know privileged information about a company, you can only deal in its shares when that information becomes public.

Directors will typically receive a monthly or quarterly confidential dashboard showing how well the company’s doing against its chosen key performance indicators. They’ll also be aware of anything out of the ordinary being planned – they’ll have inside information on proposed acquisitions or sales and of any likely fundraising, especially if shareholder approval would be required. Timewise, that leaves them with only comparatively small windows during which they’re allowed to buy or sell, which in most cases occur immediately after the announcement of the latest financial accounts.

Not all directors are equal. The non-executives are part-timers, and by definition not employed by the company. Several will be classified as independent. Their knowledge of the company relies on their experience, the briefing information they receive in advance of meetings, and from discussions within and without the boardroom. To save overloading them, executives have to limit what they pass on, and they often work on a ‘need to know’ basis. There is a view that non-executive directors can take a more objective view of the company than executives. Recently appointed non-executive directors tend to buy shares in their new company as a matter of course; it’s their subsequent buys and sells that can be a more reliable indicator of good or bad times to come.

The executive directors, normally the chief executive and finance director, are best placed to spot trends. They have an overview of how the company is operating and performing, where the challenges are, how they’re being overcome (and if not, why not) and what’s likely to arise. They’re expected to know every detail but, like us all, they in turn have to depend on others. Their sources will be both formal and informal discussions and reports from their team, together with conversations both inside and beyond the organization.

Their sales can be for a number of reasons. It might be to do with their pay, most of which is performance-related, and tied up as company shares. Sales could be to settle the tax liability incurred when a tranche of company shares is transferred into their name. They’ll probably be required to accumulate the residual shares until they’re worth more than several years of their annual salary, so that they personally experience the pain or gain of other shareholders. Some directors are comfortable with having such a high proportion of their personal wealth tied up in one place, especially if they or their families built up the business from small beginnings. Others might sell some of their shares when they can, simply to diversify their investments, or maybe for personal reasons, such as divorce or a large property purchase. For smaller companies, we often hear that the reason is to satisfy investor demand, meaning that directors have sold a tranche of their shares to fund managers who would have struggled to build a meaningful stake through open market purchases. This always raises a cloud of skepticism. Is the reason genuine, or being cited as an excuse? Perhaps they see storm clouds ahead.

Executive directors are paid so much in company shares that they don’t need to buy more, so when they do, that’s worth watching. There is, however, a different type of buying that’s best discounted, which is when orchestrated purchases are made by several directors, especially for token amounts, after disappointing results. The intention is to signal faith in the company’s future, but it’s more convincing when several buy after positive results, since their purchases then suggest that they expect fundamentals to improve more than the market is predicting. Across the US market earlier this year, a general uptick in directors’ purchases relative to their sales has been interpreted as flagging the subsequent rise in the US stock market, but whether that would work as an indicator for the UK market is not clear.

Executives often complain that their companies are undervalued, but few back this up with personal purchases. When they do, that shows commitment, especially if the numbers are large. But does this stem from informed confidence or self-delusion? The reality is that nobody knows where share prices are going, and nobody can predict events more than one or two years ahead. Not helped by restrictions that box in when they can trade, directors often buy too high and sell too low, just like anyone else. Even so, understanding the context of each deal gives some insight – for which the ‘Director Deals’ section of Investors’ Chronicle is a good start.

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