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Can you make money following director share trades?

Photo of Michael Kemp, Barefoot Blueprint By Michael Kemp, Barefoot Blueprint

min read

Understand the signals when company ‘insiders’ buy and sell.

A couple of years back, Blackmores’ former managing director, Christine Holgate, could hear the sound of bells ringing. Yes, she was about to tie the knot, but it wasn’t wedding bells she could hear. Her Blackmores shares had climbed a staggering five-fold over the previous 12 months.

Holgate cashed in some of her Blackmores chips and received a very handy $4 million.

Blackmores’ founder, Marcus Blackmore, wasn’t quite so lucky. Earlier that year he had sold 150,000 shares, only to watch Blackmores’ share price rapidly quadruple, missing out on $26 million $26 million.

It should remind us that judging where a company’s share price is heading is a pretty tough gig, even for those who are in the best seat to know.

But it’s an interesting thought, isn’t it? Directors’ trades in their company’s shares are easy to track because they must be flagged to the market. So, the question is, can you achieve a market-beating edge by parroting the buy and sell orders of directors? That’s what this article explores.

It’s all about buying

Famous US fund manager, Peter Lynch, once said: “There’s no better tip-off to the probable success of a stock than when people in the company are putting their own money into it. When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months.”

Notice that Lynch referred only to buying and not to selling, and there’s a reason for that. People sell for plenty of reasons, such as when they want to buy a new house or boat, to pay school fees or to settle a divorce. Which means selling does not deliver the pure unadulterated market signal that boardroom buying can.

Unlike selling, buying is undertaken for a singular reason. Let’s face it, why else would a director shell out their hard-earned money other than a strong belief that the share price is about to head north?

Which leads to another important point – make sure that what you are observing is real buying; that is, when directors open their own wallets. Allocations of shares through executive share schemes or the exercise of company-granted options simply don’t cut it.

When directors are permitted to trade their company’s shares

Directors are not permitted to buy and sell based on information that has yet to be disclosed to the market, which means their trading is restricted to certain periods.

Those times are spelled out in the company’s Securities Trading Policy, which must comply with the minimum requirements in ASX Listing Rule 12.12. It is not prescriptive; rather, 12.2 requires that a company defines the trading limitations most appropriate to its own circumstances.

Therefore, companies define closed or blackout periods when directors are prohibited from trading in the company’s securities. This is typically the time between the closing of the company’s books and the public disclosure of its financial results. But any period, if seen as appropriate, can be specified by the company.

Outside these periods, it’s open slather for the directors and game on for anyone who wants to check out what they are up to.

Where you can find the information

ASX Listing Rules provide that a listed entity must advise ASX of any changes to a director’s holdings no more than five days after the date of change.

This information is available to the public in the company announcements section of the ASX website. Specific director dealings are disclosed under the heading ‘Change of Directors Interest Notice’. You can also check them by clicking on the announcements tag once logged into the website of your favourite internet broker.

To make your life even easier, some investment newsletters collate and interpret this information for their subscribers. If you don’t feel like paying for a subscription, go to Google because there are free sites that collate the data.

Can you make a buck by following the insiders?

Now we get to the interesting bit. UK research company, Director Deals, looked at share price changes following directors’ transactions between 1999 and 2003. It found that significant buying by directors was followed by an average rise of 23.5 per cent in the year after the purchase.

Significant selling was followed by an average fall of 15.5 per cent.

European Business School academics, Dardas and Guttler, analysed short-term announcement effects for 2,782 companies from eight European countries between 2003 and 2009. In keeping with intuition, they found the magnitude of the announcement effect depended upon the transaction size and was more significant when there were multiple trades by different directors on the same trading day.

They also found the results were stronger for purchases than sales and the corporate position of the director was positively correlated to the size of the announcement effect.

Nevertheless, a study of director dealings should not be used as the sole basis for making investment decisions. They represent but one piece of information and must be interpreted within the context of all available information. They do not represent a substitute for a full analysis of a company’s fundamentals.

About the author

Michael Kemp is chief analyst at The Barefoot Blueprint and author of the popular sharemarket book, Uncommon Sense: Investment Wisdom since the Stock Market’s Dawn, published by Wiley.

From ASX

Announcements on the ASX website lets you search for important information about market announcements, by company.

The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2017 ASX Limited ABN 98 008 624 691. All rights reserved 2017.
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