Introduction


In August 2004 we undertook a study of our data to establish whether investors who actively invest in response to Director trades are able to beat the market.

Directors make transactions in their companies' shares in many different ways and for many reasons. Our reporting method is designed to convey the exact nature of a transaction by describing it using one of our twelve transaction types.

For investors, following transactions which are, for example, routine dividend reinvestments, is unlikely to provide a reliable insight into likely future stock performance. However, a straightforward 'Buy' transaction is a greater expression of a director's confidence or otherwise in an investment opportunity and is therefore more worthy of further analysis.

Under our method, a 'Buy' transaction is a discretionary trade with no remunerative element transacted at the prevailing market price.

Directors Deals analyse every transaction we record according to our proprietary methods to assess its meaning. We record this assessment in the Transaction Significance Index (TSI) which is explained in more detail in the client section of our website.

Screening transactions according to this and other information we hold, does, according to historic data, pick out transactions that indicate likely future share price movements.

The following study was carried out in August 2004 and was intended to statistically analyse whether following transactions which our method states are significant, can lead to market out-performance.

Our sales team can help explain how effective and valuable our data can be in the investment process. Please Contact us for more information.

Screening


We screened transactions on three bases so that the study excluded insignificant transactions. The screening criteria used were:

Comparison
  • Transaction Type - We included Buys and Sells only, thus excluding transactions such as dividend reinvestments and awards.
  • Announcement Date - The study was done in August 2004 and because the study required share price performance for a year post-trade, we only included transactions up to August 2003.
  • Transaction Significance Index - We excluded all transactions with a score below 70 which means that we only included the top 30% of transactions. In practice this means excluding low value transactions and those where the change in Directors' holding is very small.
  • Other Criteria - If our database was missing historical share prices for the stocks concerned or the price data appeared unreliable, the transactions were excluded. Share price data for some foreign listings is not always available and Corporate Action can result in data being unavailable.

Comparison

We compared the share price of each stock in the year following the transaction to that of the FTSE All-Share Index [hereafter 'Index'] over the same period. For Buys, increases in the share price were recorded as positive growth; for Sells, decreases in the share price were recorded as positive growth.

We aggregated these results, with each transaction equally weighted, regardless of whether there were multiple similar trades, or of any details such as trade value. We also calculated out-performance figures for each transaction, being the degree to which growth in the share price exceeded growth in the Index, over the year following the transaction.

Calculation and Conclusion

Each annual out-performance figure was calculated as follows:

For Buys

Share price 1 year post-trade - Share price on transaction date


Index 1 year post-transaction - Index on transaction date

For Sells

(Share price 1 year post-trade - Share price on transaction date ) x-1


Index 1 year post-transaction - Index on transaction date

Results

Mean growth per transaction: 22.5%

Mean out-performance of the Index: 26.9% [The Index fell in the period concerned]

Buys out-performed sells, with stocks bought rising by an average 23.5%, while those sold dropped by 15.5%, making Buys better predictors by 8%. The standard deviation on buys was around 1; double that for sells.

Conclusion

Having screened the transactions as described it is clear that following these Director trades can predict aggregate future share price performance. Both Buys and Sells are predictive although Buys are more so.