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Beat the market by following director share buying

Director dealer – professor Tonks

One way that foolhardy brave investors look to beat the market is by following the share trading of company directors in their own company’s shares.

Directors are not allowed to trade on inside information.

But they are arguably best-placed to read the runes about their industry, and to know how much their own confident talk is hot air, versus a hot tip.

At the very least, if the financial director of Widgets, Giblets and Co. is prepared to put £50,000 into shares of the company he manages, you can be pretty sure it’s not about to go bust.

Now academics have produced research that claims to prove that following director buying of Value stocks can indeed generate superior returns.

Following director selling was found to be pretty much a waste of time, though.

Directors buy value

The new research comes from the University of Exeter Business School.

Professors Ian Tonks (pictured above) and Alan Gregory found company directors consistently trade in a contrarian fashion.

This means they buy more Value stocks and sell more Glamour stocks, and they buy following price falls and sell following price rises.

The professors define Value and Glamour stocks in the usual way:

  • Value stocks have low prices relative to fundamental measures of value, such as book value, earnings, cash flow, dividends or sales
  • Glamour stocks have high prices relative to those fundamentals

The research covered every director’s share trade made on the London Stock Exchange between 1986 and end of 2003, although certain trades were removed:

  • Investment trusts, property companies, insurance companies and banks were excluded
  • ‘Trivial’ trades – defined as having a net value less than £20,000 – were removed

The share price performance following a trade was analysed over a two-year period to the end of 2005.

Market beating results from directors dealings

The heaviest out-performance was concentrated in smaller value companies.

Directors’ trades in these small value stocks showed an average abnormal share price return of up to 20% more than control groups of similar firms over two years.

Directors’ trades in large value stocks demonstrated a more modest outperformance – just over 6% over the same period.

According to the paper’s co-author, Professor Alan Gregory:

“Our research shows that corporate insiders – both non executive and executive – make use of their private information to generate abnormal returns. This information is not reflected in the metrics constructed from publicly available information.

Directors’ trading signals clearly significant returns on Value stocks on the Buy side, whereas the modest negative returns on the ‘glamour’ stocks’ sell side are not generally significant”

Why following selling doesn’t work

It makes intuitive sense to me that following director selling isn’t very useful.

A director may sell shares for any number of reasons:

  • To get the money to buy a sports car
  • To pay a tax bill
  • To meet his or her divorce proceedings
  • To diversify a portfolio

In contrast, about the only reason anyone buys shares is because they think they will go up in price.

The exception is ‘token’ share buys by directors who are trying to signal to the market they have faith in their company, when perhaps they don’t.

The professors exclusion of trades under £20,000 in size probably got rid of most of this buying from all but the richest directors.

Should you follow the directors who buy?

At least one professor is backing his research with his own money, according to an interview I heard on BBC Radio 4’s Money Box at the weekend.

If you want to join him you can follow director trading using this page of the Digital Look website, or in magazines like Investor’s Chronicle.

There’s also a blog dedicated to tracking UK director buying and selling called followthedirectors.

The fact that these resources are available shows the findings aren’t ‘new’ as such.

It’s a curious question therefore for efficient market theorists to explain why this apparently well-known anomaly hasn’t been ‘outed’ and arbitraged away by the market?

If directors have been filling their boots with bombed-out shares and getting richer in the process for 20 years, why didn’t someone else notice?

Nothing lasts forever

Perhaps this new research will popularise the strategy to such an extent that excess returns will indeed be smoothed away by myriad investors jumping on the bandwagon.

As ever, past performance is supposedly no guide to the future.

Personally, I do look deeper at a company where directors have been buying when doing my own stock picking. But this is very different from the mechanical approach tested by the professors.

As ever, an index tracker is the best way for most people to invest. But if you’re going to trade then this research looks well worth taking into account.


The Motley Fool has just published an article based on the same research, pointing out that you can’t buy exactly when the directors buy, and that the price will often have moved higher once they do.

This is definitely true; it’s also been raised by reader Financial Samurai in the comments below.

Directors deals are worth taking into account when evaluating a share, but they’re no shortcut to riches.

Further reading:

  • You can download the full research paper entitled Insider trading in Value and Glamour Stocks.
  • Citywire has interviewed the professors who followed the directors deals.

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{ 4 comments… add one }
  • 1 George December 16, 2009, 5:41 pm

    Wow. Outstanding info! I love your analysis that insiders buy for one reason and sell for many.

    In fact, most insiders of successful companies will sell even when they have confidence in their company because they want to reduce their risk. Their stock may be worth millions or tens of millions of dollars, and their entire net worth is in the company stock. It makes sense for them to sell some of it, no matter how certain they are that their company will succeed.

    Another interesting development is the availability of the information. The internet makes it possible to follow these director’s buying decisions faster and more accurately.

    Thanks for the great post and the great links!

  • 2 The Investor December 17, 2009, 7:26 am

    Thanks for the comment George. I agree, though it’s interesting to think of contrary cases, such as Warren Buffett who I believe has never sold Berkshire Hathaway stock, though he has given some away.

  • 3 Financial Samurai December 17, 2009, 3:48 pm

    Tis an interesting idea, however I’ve seen so many insiders get it wrong, so it’s not a sure thing by any means. I would attribute insider buying to a 10-20% weighting in my decision making MAX.

    The other thing is, by the time we no the insider bought, it could be a month away!

    Good to keep an eye on things though.

  • 4 The Investor December 17, 2009, 6:37 pm

    Yeah, the time delay point is a great one FS. I’m going to update this article in a moment with a link to an article pointing this out.

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