|Click to enlarge. Example of share price |
movement after a director purchase
The picture below is an example of a director buy RNS. It concerns Rialto Energy (LSE:RIA). The title of these RNS' tend to be either 'Directors Dealing', or 'PDMR Shareholding'.
The above example is fairly self explanatory. Most cases are as simple as that. They outline how many shares were bought, when, and at what price. The resultant shareholding is usually shown.
Now you may be thinking it's easy. Buy when a director buys. Surely the director knows more than the average investors as they are running the business, hence it's easy to make money! Unfortunately not. First and foremost, due to legislation, directors are not allowed to purchase shares with the intention to trade them. Therefore they have a long term viewpoint. Beyond that, many directors completely mistime their share purchases and ultimately it is the company's performance that determines future price changes, not the director buys. There is also a rule that means that directors cannot purchase shares when they either have access to unpublished price sensitive information, or are in a 'closed period'. The former restriction is easy to understand. A director cannot purchase shares just before a takeover is announced, for example. Relating to the second restriction, a closed period extends two months before the publishing of a set of results. The reason for that is once again to prevent the directors buying into information ahead of the market. Yes they run the business, but they shouldn't be able to purchase shares once they know the figures. This rule is to prevent that. For that reason, investors often look for share purchases either side of the closed period and the results announcement. If they purchase shares before the closed period, it is often a decent indication of how the results are going to look. If they purchase directly after the results, it is also a positive signal as they are confident looking forward, or believe the market is undervaluing the shares. Either way, it can be a useful signal.
However, it's not always useful. As I said, directors can time their buys incorrectly and may have side-motive when buying the shares. For example, they may simply be trying to prop the share price up in the short term. Below is a case where following director buying (at Amara Mining LSE:AMA) has been a surefire way to lose money.
|Director buys have not be useful at Amara Mining|
Clearly, anyone who purchased shares in tandem with the directors would have been very disappointed with Amara's price performance. The shares have dropped steadily, over the period shown. Despite that, director buys have been accumulated along the entire stretch. There is a point to pick out now. Directors tend to sit on shares. By that I mean that they purchase far more frequently than they sell, and they also tend to accumulate over time. Therefore, how inherently useful are director buys? Unless the share price goes up consistently over time, the (general) overall accumulation means there will be a growing disparity between the number of shares held by directors, and the share price performance.
Therefore it is important to be able to discern how useful an indicator any particular director buy is.
A few points to check when evaluating a director buy
- Which director purchased shares? A CEO purchase is more useful than that of a Non-Executive Director. The reason being that the CEO is more involved with the company
- How many shares were purchased? This should be in actual £GBP. A £300,000 share purchase is a more positive sign than a £10,000 share purchase. In addition, how does this share purchase compare to the director's annual remuneration?
- When has the share purchase come in the price cycle? A share purchase near a share price dip is perhaps indicative of a change in the company's fundamentals. Importantly though, a common situation to look out for is when a share price spikes downwards. It is common for directors to try and 'calm the waters' by buying shares in order to reassure the market. Remember though, fundamentals reign over a director buy so it may be a case of damage limitation by the directors
- What sector does the company operate in, is the company revenue producing? A director buy in an income producing industry is arguably more useful than one in an oil and gas exploration industry. The reason is that oil and gas exploration is a risky business and thus there are less concrete reasons for a director to purchase shares outside of what is already known by the market
- How large is the company? Many investors consider director buys in smaller companies as a more useful signal than a director buy in a large company
- How many directors are purchasing shares? The more directors purchasing the shares, the more positive the signal
- If possible, look back at the director's previous share buying record. Has the director timed previous buys correctly, or as in Amara Mining's case, has it been a stream of successive poorly times buys? Has the director sold a large chunk of shares before and how does the profit from that sale compare to the size of this buy?
The most important thing to remember though is that directors are not always right in their timing. It is important to be able to distinguish between which directors buys carry meaning, and which are of little meaning. Through following a check point system, such as that above, you should be able to do that. Do remember though that director buys should be used as an indicator, not a trigger. A director buy should only be used to reinforce an existing view you have of the company, not form a new one.