23/01/2008 - 22:00

Directors' interests ours too

23/01/2008 - 22:00

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I was interested by a report from a stock market analyst this week that showed directors who bought shares in their own company substantially outperformed the market.

I was interested by a report from a stock market analyst this week that showed directors who bought shares in their own company substantially outperformed the market.

Over four years Keith Nielsen, from a group called The Inside Trader, reckons directors who bought their own shares made a return of around 200 per cent.

The one-year average was 58 per cent, compared with a bull market average of 25 per cent for the rest of the investing public.

Mr Nielsen said his analysis of 6,837 directors’ trades from September 2003 to September 2007 confirmed what many punters already knew.

“The main reason for carrying out an analysis of this calibre is to decide whether following directors’ trades can increase your chances of trading success,” he said in statement.

“The short answer is, yes.”

But Mr Nielsen said there were some nuances to this, such as:

•bigger trades have greater accuracy but smaller trades have the biggest percentage returns;

•smaller companies seem to give much better chances of bigger returns;

•where more than one director is buying, the accuracy and share price gain is increased; and

•the gains are bigger and more accurate the longer the period from the trade.

I found this information fascinating, even though it could be perceived as being obvious.

It reinforces the decision we made many years ago at WA Business News to publish the directors’ interests announcements for board members of WA-listed companies.

Many times we have been told that this is a section readers turn to first when they receive our newspaper.

Not only does this section of ours show the various trades, it also gives an estimate of the value of the directors’ current holdings, so there is an element of voyeurism in this – we all love to know who’s got the money, especially when big names are involved.

However, directors’ interest clearly goes well beyond titillation for readers.

Buying and selling shares in the company is legitimate guide to the directors’ thinking, as the analysis above suggests.

Perhaps this guide has been less useful in recent times.

In many respects, the strength of the markets has been such that the buying side of the equation has heavily outweighed the selling side for at least the past three years.

Nevertheless, this sort of information allows investors to see who really has skin in the game, as the expression coined by Warren Buffett goes.

Of course, that buying comes with some restrictions. The more credible the director, and the company, the more likely that their share buying behaviour will be restrained by rules and guidelines. An example is trading windows, periods deemed sufficiently removed from financial reporting or other significant announcements.

The real test comes if the view is taken that the market has turned.

Directors of companies have a right to take profits, but it never looks good when they start to sell down.

After such a wave of buying, it is inevitable that larger scale selling will take place at some stage.

We regularly ask directors why they are selling shares and their responses generally relate to the need for cash to buy other assets, such as swimming pools, cars or houses; or to re-weight their portfolio.

It is difficult to distinguish between genuine reasons and those that are simply manufactured to cover up more nasty alternatives.

I don’t recall ever hearing a director say they were selling because the company they were with was a bad investment.

Whoever invents a foolproof bulldust detector for press releases will make themselves very rich on the investment decisions based on its findings.

A resignation is one thing that can mask that kind of selling. Once a director has quit the board of a company they are no longer required to announce their transactions, unless they hold 5 per cent of the company or more.

While I have nothing more than a hunch that this practice occurs, one thing I’d look out for when the market turns is directors quitting boards, especially those who have been very active buyers over the past few years. That may be a signal regarding that company’s fortunes.

Again, directors have a right to step down when they want. They may feel they’ve done the job they were brought on board for, felt their time was up, or that they no longer wanted to be involved with that entity.

They may also not want their money tied up in a company in which they no longer have an inside view. Given the proof that directors do better from trading than other investors, there’s probably good reason why they wouldn’t want to be in the dark, as the rest of us are.

It’s certainly rare to hear anything but the most sanitised reasons for board departures, so they are unhelpful as a guide to the future performance of the company involved.

Given the correlation between directors’ trading behaviour and investment performance, perhaps, in the interests of transparency, ex-directors should have to disclose share sales in their former companies for a period such as a year.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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