In terms of the company itself, it is of course the Directors who should be in the best position to judge the health of current and future performance. They are aware of strategy, sales of product lines, awarding of contracts and the strength of their Profit and Loss account. As such, they are perfectly entitled to put their money where their mouths are, and such indicators are pored over by the investment community.
In addition, recent market falls have provided buying opportunities for those executives with faith in the long-term future of the business.
This is not to say that Directors may make purchases (or indeed sales) at will – they are bound by a strict code which, amongst other things, recognises that they have access to certain privileged information. To avoid being caught by the Insider Dealing rules, they must not carry out any trades on the basis of having information which is not already in the public domain, nor indeed information which could be described as being “price sensitive” – in other words, facts which would move the share price if known. In addition, Directors are not permitted to deal in the “Closed Period”, which is the two month window ahead of their company’s results.
The reason that the whole issue of Directors’ dealings has assumed more focus over recent years is that, as with so many other walks of life, access to information which was previously only available to market professionals is now widely distributed and so any clues as to a company’s health can give an edge. If the CEO is a buyer of the shares – or, perhaps even more tellingly, the majority of the board – there may well be a wave of confidence which can be read into any purchases they are undertaking, particularly if they are purchases which are large either in monetary terms or relative to the amount of shares in issue. Almost needless to say, there have been occasions when the faith of the Directors has proved to be misplaced but if there has been a large investment in the shares by the board, some would argue that an owner mentality has been established, which is usually good news for a business.
By contrast, large scale sales of shares by Directors can be taken as a negative by the market. This can either be because the Directors have less faith in the company, or indeed that they believe the share price has gone far enough for now. This is not necessarily the whole picture, however – Directors may be selling shares for a number of personal reasons, such as managing Capital Gains liabilities, settling a tax bill, school fees, meeting other liabilities or simply improving individual cashflow. There have even been occasions when institutional demand for the shares has been so strong (more usually for smaller companies) that certain Directors have sold their shares so that the demand may be mopped up, with little effect on the share price.
The trends of dealing in a company’s shares from the senior management, or indeed the number of the shares that the board already hold individually, can be representative to the market of the board’s confidence in future prospects. That many executives are now judged on share price performance could also provide a clue as to why they are buying the shares.
The details of Directors’ dealings are now covered widely by various financial journals and websites and so the private investor can also look over these details and decide whether the board are indirectly giving a clear indication of their thoughts. Of course, Directors’ dealings should not be taken in isolation as a reason to invest in (or exit from) a company, but they can nonetheless provide some very useful pointers.
Richard J Hunter
Head of UK Equities
Hargreaves Lansdown Stockbrokers