There are many rules of thumb an investor learns early in their journey. One of these is that directors buying stock ought to be positive for the share price and directors selling stock is a red flag.
The theory goes that directors are insiders and should have a better feel for how a company is travelling than us outside investors.
Sure, there could be valid reasons for directors selling stock. But after years of hearing these reasons, they tend to become repetitive and sound more like excuses. “I have a big tax bill this year,” “I’m buying a property,” and “I’m going through a divorce” come to mind.
If a company’s prospects are as bright as many annual reports would lead us to believe, surely these directors could borrow money to hold on to their shares. There seems to be no shortage of money around when directors purchase stock. I’ve never heard one say “I wanted to buy stock but couldn’t cough up the cash.”
With that said, let’s test the theory with some examples from 2016.
Instances when the theory held true: director sales
Brambles’ (BXB) outgoing CEO Tom Gorman was “embarrassed” by last month’s profit warning, which saw the company’s share price drop 16% on the day. Perhaps this is as much due to his disposal of $8.4 million of stock in August 2016 as his desire to depart with the company in good shape.
Sirtex‘s (SRX) former CEO Gilman Wong was terminated last month. He sold $2.1 million of shares in October 2016 followed by a poor trading update six weeks later. The share price fell 37% on the day of the update.
A board spat, a questionable acquisition and industry pressure from NBN costs all plagued Vocus (VOC) in 2016. Founder James Spenceley sold most of his holding for $26.6 million in August with several other directors selling shares soon after. The share price was close to record highs at the time but started heading south. By the time the company released disappointing earnings guidance at its November AGM, the share price had more than halved.
Both Bellamy‘s (BAL) outgoing CEO Laura McBain and Chairman Robert Woolley sold stock throughout 2016 ($6.6 million and $4.4 million respectively). This preceded a December trading update, followed by a trading halt and January downgrade, which was accompanied by inventory write downs, foreign exchange losses and restructuring charges. The share price is down 69% since the first trading update with IMF proposing a class action.
The largest sell-down of 2016 was by Vita Group (VTG) founder Maxine Horne. Her registered interests sold $91 million of shares or just over 16% of the company. These preceded an opaque November announcement of a change in commercial terms with strategic partner Telstra. The share price is down 35% since her most recent sell-down.
Instances when the theory held true: director purchases
Pleasingly, two of Forager’s holdings supported the theory that directors buying shares are a precursor of good things to come.
We like it when management has ‘skin in the game’ and were pleased to see Dicker Data (DDR) co-founder Fiona Brown buy an additional $1.8 million shares back in March. The share price subsequently increased 56%.
Service Stream‘s (SSM) 30% share price decline in just one month (over October / November) on little news flow had us scratching our heads. The directors must have felt the same as us, with four of them buying stock in November. The company was awarded a $120 million NBN contract in late December, with the share price recovering most of the decline.
Instances when the theory didn’t work: director sales
Not all directors traded shares as fortuitously as the aforementioned. Some directors sold stock and left a lot of money on the table.
Nanosonics (NAN) chairman Maurie Stang sold $4.7 million in February (after selling $6.0 million in May 2015) before the share price increased 60% over the remainder of the year.
Galaxy Resources (GXY) director Michael Fotios sold $11.3 million of stock before seeing the share price rise 34%. Similarly, Mineral Resources (MIN) chairman Peter Wade sold $8.0 million of stock, which preceded a 48% share price increase. Perhaps the rebound in commodity prices in 2016 prompted both to take some profits.
Instances when the theory didn’t work: director purchases
On the flip side, some directors overestimated their company’s prospects. Several behavioural biases could have occurred, such as overconfidence. Or perhaps familiarity bias – more knowledge makes the investor more comfortable owning stock. But this doesn’t always lead to a profitable outcome.
Estia Health (EHE) co-founder and former director Peter Arvanitis made several share purchases throughout 2015 and the first half of 2016 at more than double the current share price. CSG (CSV) director Thomas Cowan purchased $5.8 million shares in August and a further $0.6 million in September. A disappointing trading update in November saw the share price fall 37%.
Are there any common themes?
Co-founders and directors with lengthy tenures tended to be wrong when amounts bought or sold were small relative to their total holding (although large in absolute terms). But major sell-downs (greater than $25 million) by founders tended to be more accurate leading indicators. Management selling shares tended to be a red flag more often than not. But probably not often enough to conclude that you should sell your shares as soon as management does.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.