UK: Self interest - Follow your leader.

UK: Self interest - Follow your leader. - Many investors look to directors' dealings for a lead and then mirror their moves. As an investment strategy it can pay dividends but, Alistair Blair suggests, it is not free of pitfalls.

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Last Updated: 31 Aug 2010

Many investors look to directors' dealings for a lead and then mirror their moves. As an investment strategy it can pay dividends but, Alistair Blair suggests, it is not free of pitfalls.

It is always wise to check the share dealings of directors when buying a stock. The information that someone in the know has recently sunk a decent amount of money - anything over £10,000 - into the stock is reassuring.

Regardless of how much research other investors have done, they don't know a fraction of what the insider knows.

Of course, it doesn't give protection from mishaps. In late 1995, several directors bought into the engineering firm Wellman at around 50p. They'd been big buyers a year or so earlier at less than half that price and, to cap it all, had sackloads of options. The sight of directors putting still greater amounts of their personal wealth into the shares was enough to arouse the interest of even the most cautious stock picker. With Wellman currently coming up for air at around 25p, one can only be philosophical about the dangers.

The little Irish stock, Arcon, holds more pleasant memories. When Arcon announced a £50 million rights issue to pay for the construction of its zinc mine the share price halved. But there was at least the ubiquitous (and very rich) controlling shareholder Tony O'Reilly underwriting a huge chunk of the rights issue at 20p per share. He put in £20 million on top of the £10 million or so he'd paid to get control. In O'Reilly's case, a £10,000 investment wouldn't impress one jot, but this level of commitment was convincing. Those shares have now bounced back strongly and the 'johnny-come-lately' investors are as happy as O'Reilly must surely be.

It's important to remember that directors' sales of shares don't necessarily have the same significance as their buys. 'Legitimate' reasons for directors to sell include tax, divorce or a bigger house. They say nothing about the company's prospects. There may be times when buying is driven by non-investment criteria: seeking control and dynastic motivations being the obvious candidates. However, you can often tell from the circumstances whether either of these syndromes is applicable. When they aren't, by contrast with the many possible motives for directors to sell, you've got just one reason why they're buying: they think the shares are going up.

Even so this is in no sense a market-beating system. Academics put out regular (and ferociously mathematical) studies which find alternately that it is, and isn't, a good indicator. The Financial Times crawled over the subject last year and suggested that if you bought when you saw several directors buying together just before the closed period (the eight weeks running up to a results announcement during which directors cannot deal in their own shares), then you could, maybe, steal a point or two on the index.

Last year Investors Chronicle carried a survey of 253 instances in which directors invested £150,000 or more in buying their own shares. This suggested that by blindly following the lot, you might have outperformed the index modestly, but if you restricted yourself to situations where a director seemed to be buying for a recovery after the shares had taken a beating, you could have been quids in. A word of warning, however. You also need to be patient: only a tiny minority of cases foreshadow an immediate spurt in the share price.

Only one fund manager openly makes director dealings the keystone of his strategy. This is Charles Cooper, who runs the tiny Ely Place BRI Director Dealings Unit Trust, initiated in 1993, since when it has turned £1 into £1.34. The trust's performance has been a real tale of two halves.

As Cooper points out, most directors are directors of small companies, so being driven by their dealings biases you towards the tiddlers. Because it was the blue chips that got the current stock market surge under way in 1995, Cooper found himself being left behind. Once he had recognised and adjusted for that, his performance got back on track: over the last 12 months he was a point ahead of other UK growth unit trusts.

Directors' dealings must be announced to the Stock Exchange within five days. But where do you find out about them? For most private investors the best source is Saturday's Financial Times, which lists all transactions worth £10,000 or more. That list, however, is up to three weeks out of date. Investors who wish to be quicker off the mark must pay £1,300 a year for the Directus service which gives day-of-announcement tracking of directors' dealings.

Only if you fork out this sort of cash do you gain access to more timely knowledge - and even then a word of caution: director share dealings can add to convictions about a stock, but should never be treated as a decision-maker in their own right. Stocks (as we all know) can go down as well as up - even directors have bad share days.

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