Directors’ Dealings – Information, Noise and the role of Randomness

I was reading an article about the directors of Imperial and Steinhoff purchasing shares in their respective companies. Steinhoff directors made the news when the CEO originally used Single Stock Futures to gear his exposure to a significant position in the company. (This position has since been converted into a direct position with about the same total exposure.)

This raises the question of whether directors’ dealings provide information as to the future performance of the company.

Information content of directors’ sales

Directors may sell shares for many reasons unrelated to perceived valuation differences in the share price. A director may sell to raise cash for other purposes, to decrease exposure to a single company, in a single entitty, in a single country where salary and bonuses are also tied to that company’s fortunes.

Information content of directors’ purchases

On the other hand, directors buying shares in their own companies is usually a good sign. Putting management’s general optimism about their own businesses aside, if they believe that their business is significantly undervalued, the incentive to buy more shares make this a worthwhile sign. This is especially true given the reasons mentioned above to reduce exposure to your own company.

Empirical evidence

I don’t have the references at hand, but I’m fairly confident that this has been supported to some extent by empriical “event” studies that analyse the relationship between Total Shareholder Return and purchases and sales by known company insiders.

The other side

Steinhoff’s performance recently has been quite horrible. A mixture of trading conditions and global economic changes (exchange rates amongst others) have meant that the share expecting operating performance of the business had deteriorated. The share has been accordingly downrated – see the chart below (the purchase was in July 2007).

Steinhoff Share Price Peformance 2007

So in this case, a heavily geared vote of confidence in the company by knowledgeable managers did not provide useful information (over the 6 or so months since that point) to outside investors. But before we throw the baby out, consider the following points:

  • This is one example. We (hopefully by now) don’t expect to hit gold with every turn of the wheel.
  • 6 months is a short time-period for committed investors (not traders) who may be happy to stick by the company for 5 or 10 or 50 years. If the prospects of the company are good, they should be good for a longer period than 6 months.
  • Very much related to this point is the idea that the swings of the global economy and exchange rates and the day-to-day vagaries of consumer confidence, inflation and interest rates are difficult to predict. We should not judge a decision at a point based solely on the outcomes. We must consider all other possible outcomes as well, weighted by the probability of their occurrence, and then we can fairly assess whether the decision was appropriate or not.

So what now?

Am I going to invest in Steinhoff? Well, no, not yet, not until I have actually done some proper research into the fundamentals of the company. And also not until I have understood the reasons for the decline in price over the last year properly. If the market thinks they are worth less, I had better know why the market thinks so before I disagree too strongly.

Having said that, I pay careful attention to knowledgeable insiders when they put their money where there collective mouths are and vote with their personal wealth and risk appetites that a company is a good bet.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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