By Clem Chambers

Clem Chambers is CEO of ADVFN (www.advfn.com). His book “101 Ways to Pick Stock Market inners” was published on 24th February 2011 

We often see reports of directors buying or selling shares in their own companies. Whatever the PR or press releases says what should investors really think about such trades? Private investment guru Clem Chambers argues that investors should take a “holistic approach” and use all the available tools to help make your decision to invest.

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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.

Director’s buying at the Same Time – Just a Coincidence?

 

Sometimes directors buy at the same time in what looks like a concerted effort to impress the market. Do not be lured in by this. So when they sell, it is 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 is 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 is 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. If these directors have been buying as the price has continued to fall and their company reports do not ring true to you,  hen write the company off. Recently we have seen the example of Facebook. A classic case of PR buzz, company director’s hyping their own company and the media getting swept away as the  listing was about to become public. As we all know now, it did not quite work out the way  Facebook wanted. Soon investors discovered that the majority of shares would remain with the  company directors, who had no real market experience or history, thus providing investors with no say in how the company is run. As a result, and also thanks to an overvalued IPO, the stock

soon started to fall following a  confusing launch full of technical errors alongside a press campaign that tried too hard to convince experienced investors who remember being burned in

the dotcom boom and crash. The experience has been a bruising one for Facebook, taking some of the gloss off of the mega-company and their household name founder Mark Zuckerburg. How they respond and recover from their market launch in the next two to five years will be fascinating to watch.

Raising Money from Directors – A Worrying Sign?

Another thing to watch out for is that sometimes companies raise money from their directors because they cannot raise money from anywhere else. Pay no attention to these situations.  His 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. Do not 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 and check the record of buys and sells. 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 should not look contrived, it should look like they are scrapping together cash on the basis they just cannot resist it. This is the narrative you are looking for, old fashion avarice.

Conclusion

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 is a green light to join them.

 

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