Directors' Dealings - Do they know what they're doing?

There has always been an air of mystery surrounding the financial activity of company directors and their various dealings. Now, the stock market being the cynical place that it is, dealers often take a negative view towards directors' dealings and their given reasons.

However, in the City and under the financial spotlight, actions can speak louder than words, so investors do have a lot to gain by keeping an eye on what directors actually do with their own stocks. Small wonder then, that there is an increasing band of private investors focusing closely on these transactions.

Putting any meaning into directors' deals can be difficult. New directors, particularly those within US based companies are expected to purchase shares upon their appointment, almost as a goodwill gesture or sign of confidence.

Under the rules and regulations laid down by the London Stock Exchange and the Financial Services Authority, directors are not allowed to deal in their own shares within the two months of any results being released. This is also known as the "closed period". Nor are directors supposed to trade when they are in possession of price sensitive information.

When a director sells a tranche of shares it is never looked upon favourably. Selling is not normally any less significant than buying but it is just easier for reasons to be produced. Normally the director will simply cite reasons such as settling a tax bill or having to sell to avoid a build up of capital gains tax.

Size matters - compare the deal to the holding!

If a director already owns a million shares and, let's say. they then buy an additional 4,000, it may be quickly breezed over as being insignificant. But if the director were to only hold 10,000 shares and bought a further 30,000, then notice should be taken, especially if it is the finance director of the company that is doing the buying as they are notorious for being overly careful with their own money!

Cast your mind back to summer 2004 when the chief executive of William Hill, David Harding, disposed of nearly his entire holding. His actions subsequently caused an immediate fall of 2.5% in the company's share price and the downturn continued for the best part of a week. Mr Harding expressed "personal reasons" for his selling but unfortunately for him and William Hill, the company had been trading strongly throughout the past two years so when investors saw the sale go through, they bolted for the door, not wanting to be left holding shares that were perhaps about to turn ex-growth. Investors' mentality was simply, "If the shares are not good enough for him to hold then they are not good enough for me either."

So why then did Carphone Warehouse not suffer the same fate when founder Charles Dunstone disposed of £10 million in shares early in June? Well, very simply, while a lot of money was raised for Mr Dunstone personally, it only amounted to 2% of the company and he still retains a 34% shareholding.

Directors' dealings can certainly be a useful tool but only if used in conjunction with past reports, figures and statements on the company's trade. Investors are right to be jittery when they see one of the top brass selling as it will never been a sign of confidence. Especially after the likes of Enron where employees were being encouraged to buy shares whilst at the same time the management were secretly disposing of theirs. Perhaps the City is right to be cynical...

20 June 2005 © Moneyextra.com

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