Home Business NewsFinance News Ask Clem: "Should I get excited when directors buy shares in their own firm?"

Ask Clem: "Should I get excited when directors buy shares in their own firm?"

17th Jun 12 9:36 pm

Clem Chambers, founder of ADVFN.com and investment guides, answers your questions

Question for Clem:

“I love to check whether directors are buying or selling shares in their own firms. It seems like the perfect way to discover their confidence in the firm they run. Do you agree?”

Clem answers:

A purchase by a director in the company he or she runs is a classic signal for investors.

Directors can buy and sell shares in their own companies during periods when they are not aware of any information which the general public is not aware of which might cause the price to move.  If they have such ‘insider information,’ they are not allowed to trade.

However, there is an important distinction between insider information and insider knowledge.

Directors have insider knowledge at all times.

No one has a better insight of a company’s prospects than its directors. Even if there is no takeover in the air or no breakthrough, a company director should know the business inside out.

From the skeletons in the cupboard to the progress in the lab to the prospects far into the future, directors have a picture no one else can expect to see.

“Sometimes directors buy at the same time in what looks like a concerted effort to impress the market. Don’t be lured in by this”

So when they sell, it’s a good bet you should sell too, and when they buy it is a good tip things are looking up, or, at worst, the share price is looking cheap.

Most PLC directors are not rich men. They might have a pretty good income, but like most people they live up to their means so that any purchase is felt, even if it is for modest sums. No one throws thousands down the drain on a whim, so a director’s buy normally comes straight from the heart -and often a hard heart at that.

However, like most things in the market it’s not quite as simple as that. There are plenty of special cases to be wary of.

For a start, always beware of ‘mad’ directors. They are out there, especially in the small cap end of the market. It’s quite easy to check for, you just need to look for previous buys and read the company’s annual statements. All this stuff is available on the net on sites like ADVFN.com. If these directors have been buying as the price has continued to fall and their company reports don’t ring true to you, then write the company off.

Another thing to watch out for is that sometimes companies raise money from their directors because they can’t raise money from anywhere else. Pay no attention to these situations. This is the dodgy end of the market, best steered clear of.

Sometimes directors buy at the same time in what looks like a concerted effort to impress the market. Don’t be lured in by this, as buying should be sparked by individual greed not PR necessities.

As an investor, you need to look at companies’ regulatory news on a site like ADVFN and check the record of buys and sell. The best sign is directors buying in an apparently random manner.

They are buying lumps of shares in an attempt to make a fat profit in the near to medium-term from a big rise in the company’s share price. It shouldn’t look contrived, it should look like they’re scrapping together cash on the basis they just can’t resist it.

This is the narrative you are looking for, old fashion avarice.

You should always take a ‘holistic’ approach and use all available tools before making your decision. You should look at financials, stock charts, financial ratios like P/E and sales to market cap, so as to get a grasp on the relative value of the business.

If the company looks cheap and directors are buying, it’s a green light to join them.

Follow Clem on Twitter @ClemChambers. Clem’s fourth novel The First Horseman, is available to pre-order

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