Director buying shares are a handy hint
IT'S an impressive strike rate. An estimated 80 per cent of company director share trade investments turn out to be profitable, according to Keith Nielsen, the managing director of The Inside Trader, afirm that tracks directors' trading activity.
Director share trades are closely followed by some investors who believe they are perhaps the best guide on when to buy a company's shares. But the federal government earlier this month proposed a crackdown on when directors can buy and sell shares that may make that strategy tougher to follow.
The government is concerned some directors are still trading during blackout periods prior to financial results being released and may be privy to price-sensitive information.
Nevertheless, Nielsen believes director share trading is a useful tool for retail investors.
"If directors are putting out money from their own pocket, then there is a good chance the share price will rise," he says.
The best clues, he adds, are on market trades, which indicate directors are using their own money to purchase the stock rather than transferring options.
"The bottom line is that they are just like you and no one will spend their own money if they are going to lose money, that's just basic human emotion," Nielsen says.
In 2007, his firm undertook a detailed study of more than 6800 director share traders in the four years to September 2007.
It found that by following directors trading in their own shares, punters could have increased their trading success.
On average, the report says directors had outperformed the general market by a factor of two (doubled sharemarket returns) with an average one year gain of 51 per cent. During this same period, the All Ords Index rose by about 25 per cent a year.
However, some industry commentators recommend caution and say while directors' share trading is a good indicator, it shouldn't be the main or only reason for buying shares.
Australian Shareholders Association chief executive Stuart Wilson says: "It's important to note what directors are doing with their shares."
He says directors' share trading "may be a useful indicator" for investors but "it shouldn't be the sole reason for your investment decision".
Fat Prophets analyst Colin Whitehead agrees: "It's important to remember that various transactions often occur for reasons beyond simply those views of the company, particularly when sale transactions are going through. It may be simply to fund the house purchase ... or it may be motivations beyond a negative or positive view on the company."
Essentially, Whitehead says, director trading actions should not be used as a "stand-alone piece of evidence", but rather as one indicator among many.
There are two periods during the year when directors are not allowed to buy shares: the periods before the company's results.
Also, they are not allowed to buy company shares before a major announcement or when they become aware of a significant event.
One example of how things could go wrong, and badly, was the collapse of ABC Learning Centres. Company founder Eddie Groves was a major shareholder in the company, with a large chunk of the shares bought on margin loans.
Wilson says directors could have any reason for selling their shares.
"They could be going through financial hardship, going through a divorce or wanting to buy a new house, he says.
"So their circumstances are going to be completely different to that of a typical investor. (Which means) it's not all together reliable."
Similarly, he says, directors buy shares for various reasons, such as receiving a cash windfall and deciding to invest.
Wilson adds: "There are also quite a number of companies that have director share purchase plans, where a portion of their fees is set aside for purchasing shares. So it could give this impression that a director is continually buying up when really it's just a factor of their share purchase plan."
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