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Could the recent spate of £1 million director buys suggest the downturn is bottoming out? Simon Keane finds out why it pays to follow the big boys in the know

More often than not directors make the right call with their share dealings. For this reason UK stock market investors should sit up and take notice of a number of million–pound plus buys of late. The message is clear – there are some bargains to be had.

Unsurprisingly, the majority of these big buys have originated from companies leading the market correction. Of the million–pound purchases since January two of the eight have come from property-linked sectors (Great Portland Estates, Galliford Try) while three were from consumer-facing businesses (Marks & Spencer, JD Wetherspoon and Topps Tiles).

In the case of Galliford Try, chief executive Greg Fitzgerald earlier this month picked up shares at an 81% discount to last year’s high and is clearly making a pointed statement in buying exactly £1 million worth of stock, to the penny. Interestingly, we have not seen any million–pound plus deals from directors of the banks.

Given the view from some quarters that we are soon to see the end of the mining sector’s protracted bull run it would be a brave investor who called the bottom of the market. But even if it takes another six months for the broader FTSE All-Share to bottom out it wouldn’t be wild to suggest that some sectors have already found their lows – the director buying we have seen points to pockets of value.

Informed decisions

More times than not directors correctly call their purchases. This would seem a reasonable assumption given they are better informed about their company than outsiders. But now academics at the University of Exeter and University of Bristol have proven the case following a three-year study looking at 182,000 director deals of Main Market companies spanning 14 years.

Unfortunately the study’s findings are the property of Knox D’Arcy Investment Management, which commissioned the research, so they will never fully see the light of day. But Knox D’Arcy is sufficiently confident to use them as the basis for a new collective to be called The Directors’ Dealings Investment Trust which is due to be launched in the next couple of months and claims to be the first of its kind.

According to D’Arcy, following director deals will have consistently worked between 2000 to 2006. To illustrate this point it has back-tested the performance of strategy ‘STP414’ over this seven-year period. STP414 is based on following directors deals in FTSE Small Cap stocks although we are not told the exact parameters on which the strategy is based (does it just follow executive directors rather than non executives or does it track single purchases or ‘cluster’ buying where a number of directors acquire at once?).

Over the seven years 58% of investments made in accordance with STP414 (and held for 240 days) gave a positive return while 32% of investments delivered a negative return. The investments which went on to outperform beat the market by a greater margin (around about +40% versus the FTSE Small Cap) than the underperforming stocks lagged the index (approximately 30% versus the FTSE Small Cap).

Knox D’Arcy’s findings are supported by those of financial information provider Digital Look which back-tested what would have happened if you had followed directors deals in FTSE 100 shares over five years. It found that such a strategy will have returned 48% more than the index.

All the evidence points towards the recent slew of £1 million director deals flagging some serious value opportunities. Since hitting its year high of 3,479 on 15 June 2007 the FTSE All-Share fell by more than 20% to a low of 2,778 on 17 March 2008 and remains about that level. But the correction within some of the property and consumer-facing sectors has been much more dramatic.

Just take a look at the FTSE All-Share Real Estate index, down 41% from 15 June last year meanwhile FTSE All-Share Construction & Materials is off 31%. The FTSE All-Share General Retailers sector is down 46% while FTSE All-Share Travel & Leisure (containing the much maligned pub companies and airlines) is off 31%. All these sectors are discounting a sharp downturn/recession in a UK economy as a highly indebted consumer is crippled by rising interest rates and a property price crash. But could it be that these concerns are now properly factored into share prices?

What about the prospect that the worries about interest rates, driven as they are by the spiralling cost of oil which is now touching $140 a barrel, may retreat as quickly as they have grown? Many commentators say that oil prices have been pumped up by speculation and we could see a rapid move back to $100. Meanwhile predictions of a 40%-plus collapse in house prices (Numis Securities) may well be overdone in which case some property and consumer facing stocks which have been heavily sold off could turn out to look like steals at today’s prices.

Bagging a bargain

When Greg Fitzgerald, chief executive of Galliford Try picked up his £1 million worth of shares in the company earlier this month he paid 31.9p which is 81% off the stock’s high of 172p reached last year. Meanwhile Topps Tiles chairman Barry Bester picked up his £1.9 million worth of stock at 75p, which is about 69% lower than the 245p high hit last year (he was followed in his buying spree by four directors).

In the last crash of 2000 it took the technology, telecoms and media stocks three years to bottom out (see box) at around 50% to 90% from their highs. This suggests that the long, drawn out correction that time may have now been replaced by a short sharp shock reminiscent of 1987.

Back in 1987 the FTSE All-Share peaked out at 1,239 on 16 July, then drifted for several months before taking its dramatic downward tack on ‘Black Monday’ 19 October. By early November the crash was done and dusted with the FTSE All-Share bottoming out on 10 November at 785. One year later and by 10 November 1988 the index had recovered by 22% to 954 – could we be heading for a similar scenario this time around? In some segments of the market heavy director buying suggests it is a possibility.

Big deals

The other big deals to have emerged in recent months include a £2 million purchase by Richard Peskin, chairman of Great Portland Estates. Peskin picked up his shares over two purchases made on 28 May and 30 May at 407.6p and 388.5p respectively. Based on the higher of those two prices his purchase was made at a 41% discount to the 690.5p year high. Chief executive Toby Courtauld followed his boss in on 2 June with a £38,850 purchase at 388.5p.

In the consumer-facing businesses we have seen Tim Martin, chairman and founder of JD Wetherspoon pick up £2.9 million worth of stock in a consideration made over three purchases of 325,000 shares at 300.8p on 11 January, 315,000 shares at 310.7p on 10 January and 297,127 shares at 333.9p on 8 January. Based on the higher 333.9p, his purchase was made at a 46% discount to last year’s high of 619p.

Rising food and energy costs, combined with the impact of increased alcohol taxes have weighed heavily on JD Wetherspoon but analysts are in general agreement that the company looks well positioned for a recovery. Earlier this month Martin returned for another 300,000 shares at 239.6p (consideration of £718,800) despite being about 20% down on his original purchase in January.

The purchase of £1 million worth of shares in his own company by Marks & Spencer executive chairman Stuart Rose in January adds further weight to the idea that some of the retailers are already factoring in the worst of the consumer downturn. Rose picked up his stock at 410.7p on 9 January on the day the company released an interim management statement warning about poor Christmas trading which sent the shares plummeting. That purchase (which was followed up by four buys from other directors) represented a 40% mark down to the 687.5p the shares had been trading at the previous year. While Rose and his fellow directors are currently down on their money, time will tell whether they are right – Knox D’Arcy found that when following FTSE 100 director deals optimal returns are made after 240 days.

There has been an absence of buying by directors at the banks which may suggest that the near 40% correction experienced by this sector in the past year is far from over. There were a series of smaller purchases last year which went on to underperform according to research from Digital Look so perhaps it is a case of once bitten twice shy.

With a slew of million pound purchases so far this year investors would do well to take notice. Markets may not have ended their downward retreat but a concentration of buying in the property and consumer-facing sectors of the economy indicate that in these parts, at least, the worst may soon be behind us.

The banks’ experience

Conviction buys by the directors of the banks have been conspicuous by their absence as the credit crunch continues to wreck havoc but it might be a case of once bitten twice shy. Bank directors have made some pretty hefty purchases since the summer correction (although only one, from Barclays’ Frits Seegers, breached the £1 million mark). However, according to financial information provider Digital Look, these buys have, in general, turned out to be bad calls.

In a study published last month Digital Look discovered that bank directors had made 62 purchases in the previous year and most of them had lost. In fact the total loss on these trades amounted to £3.3 million, a figure which is likely to be significantly greater given the banks sector, as tracked by the FTSE All-Share Banks index, is off around 17% since May.

Barclays’ Seegers, chief executive global retail and commercial banking and the group’s president Bob Diamond made the two most unsuccessful purchases when they both bought shares in August 2007 at average prices of 680p and 674p respectively. Seegers, who bought £1.9 million worth of shares, has been the biggest loser given today’s price of 312p.

Galliford Try

Chief executive Greg Fitzgerald made a £1 million purchase this month. Like other construction companies Galliford’s shares have plummeted on fears of a collapse in the UK housing market. Fitzgerald picked up his shares at 31.9p which represents an 81% discount to last year’s high of 172p. The 43 year old made another big purchase in April when he picked up 600,000 shares at 49.5p making for a consideration of £297,000. At the time Fitzgerald described the shares as ‘ridiculously cheap’. While admitting the housing market was tough Fitzgerald pointed towards the company’s other construction and infrastructure businesses.

Great Portland Estates

The fact that he is retiring in March has not stopped chairman Richard Peskin snapping up shares in his beleaguered property company. Peskin, who made a couple of large, well-timed purchases at the back end of 2002 ahead of the market bottoming out last time, picked up £2 million worth of stock in May. He bought the shares over two purchases, made at 388.5p and 407.6p, which, based on the higher of those two prices, represents a 41% discount to last year’s highs. Peskin was followed by his chief executive Toby Courtauld who picked up £38,850 worth of stock and has been back buying since acquiring 250,000 shares at 352.9p (total consideration £882,225) earlier this month.

Topps Tiles

Chairman and Topps co-founder Barry Bester picked up £1.9 million worth of shares on 29 May at 75p which represented a 69% discount to the share’s high of 245p hit last year. He was followed by president and co-founder Stuart Williams (£1.5 million worth of stock), the chief executive Matthew Williams (£37,000), finance director Robert Parker (£14,800) and business development director Nicholas Ounstead (£14,549). Commenting after his acquisition, Bester said the market was ‘tough but not suicidal’, that share prices were being driven by fear and investors had overreacted.

National Express

National Express non-executive director Jorge Cosmen took the prize for biggest director deal of the year picking up a massive £35.4 million worth of stock. This acquisition was executed over three purchases of 150,000 shares at 876p, 3,018,006 at 870p and 895,000 shares also at 870p. Based on the higher of those prices the acquisition was made at a 34% discount to last year’s high of 1,318p. The director is the former president of Spanish bus company Alsa which National Express acquired in December 2005. Analysts interpreted his buy as a signal that Alsa may not be performing as poorly as some fear following the severe downturn in the Spanish economy.

Xstrata

Last month’s purchase of £7 million worth of shares by chief executive Mick Davis can’t be taken as a value signal given the shares, like many of the miners, are currently at all-time highs. The deal should also be set in context of Davis’ recent £100 million plus bonus. The massive payout, awarded a fortnight before his share purchase, saw Davis handed £53 million in cash and a similar amount in shares, the later deferred to 2009 and 2010 in two equal payments. Shares have soared since the start of 2008 driven by takeover interest from Brazilian iron ore producer Vale.

City of London Investment Group

Barry Olliff is chief executive and founder of City of London Investment Group which has the specific investment process of investing in closed-ended investment companies (investment trusts). The group, which is focused on emerging markets, has escaped the falls experienced by the wider fund management industry. Shares have come off from January’s highs of 372.5p and Olliff picked up his stock at 335p, at discount of about 10% to those levels. The 63 year old began his City career in 1964 as a market maker at Denny Brothers and this latest deal was the fifth purchase in six months.

JD Wetherspoon

Founder and chairman Tim Martin picked up £2.9 million worth of stock in January. The acquisition was made over three purchases of 325,000 shares at 300.8p, 315,000 shares at 310.7p; and 297,127 shares at 333.9p. Based on the higher of these three prices the purchase was made at a 46% discount to last year’s high of 619p. Martin has been back in the market since keeping his faith with another large purchase earlier this month despite being more than 20% down on the January buy. Martin purchased 300,000 shares at 239.6p on Wednesday 11 June making for a consideration of £718,800.

Marks & Spencer

Executive chairman Stuart Rose purchased £1 million worth of stock in January after shares plummeted following news of poor Christmas trading. Rose made his purchase on 9 January on the day the company’s interim management statement (IMS) revealed that UK like-for-like sales had fallen 2.2% in the third quarter. That IMS sent shares in M&S crashing by 19% to close at 409.3p compared with the previous day’s 503.5p. Rose was quick to capitalise on the share price correction picking up his stock at at 410.7p and he was followed by four other directors in the course of the next week.