Stock Purchases by Directors: Identifying significant stock purchases made by company directors and understanding their potential implications.
wanna know if you should join a company's investments, given the bigwigs are investing their cash? Here's the lowdown!
Private investors seeking an edge can track insider activities – the share dealings of executives and board members – as a useful tool. After all, who better to trust than the ones running the show? But the challenge lies in differentiating valuable signals from all that background noise. That's where we come in!
Here at Stockopedia, we've analyzed over 105,000 UK director trades from 2014 to 2024 to find the sweet spots in insider buying that most often lead to future outperformance.
Rule 1: Buy Signals Outweigh Sell Signals
When evaluating insider activities, it's crucial to understand the difference between buying and selling. Many investors might feel uneasy when a director sells shares, but research shows that buy signals are far more informative.
Insiders sell shares for various unrelated reasons, such as diversifying wealth, meeting tax obligations, or simply taking profits. Sales are not necessarily linked to the company's future performance except in extreme stock valuations or deteriorating fundamentals. However, insider purchases generally signal optimism about a company’s undervalued potential and growth prospects.
Veteran investor Peter Lynch once said, "Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." Directors often act contrary, buying when the market undervalues their stock and selling when it’s overvalued.
For example, stocks typically see a 2.5% gain in the first month following a director purchase, with larger trades pushing that to 5% and even more significant gains within the following 100 days if the trade is made by a CEO or CFO.
Insider purchases indicate optimism about a company’s undervalued potential and growth prospects.
Rule 2: Cluster Buying - Multiple Directors Make a Stronger Case
'Cluster buying' happens when several directors purchase stock within a short time period. When more than three directors buy shares in three months, the average monthly returns are typically 2% higher than the market's average.
This 'conviction trade' signals a stronger consensus among the leadership team about the company's prospects, making it a powerful indicator of future share price outperformance.
Cluster buying also helps reduce the risk of misinterpreting isolated purchases that might be driven by individual financial needs rather than genuine beliefs in the company’s future.
Consider the case of Rolls-Royce in 2022. Despite pandemic-related challenges and a multi-year turnaround strategy, multiple directors began buying shares. At the time, the stock was priced at around 100p. By the beginning of 2025, after a transformative shift under a new CEO, the stock surged to over 630p. Directors who bought in 2022 – and investors who followed their lead – saw more than a fivefold return in just two and a half years, outperforming the FTSE All-Share's return of roughly 15% during the same period.
Rule 3: Follow the Top Executives
In a company, not all directors hold equal information. Board meetings, where sensitive operational and financial details are discussed, serve as primary information hubs.
Executive director buying – particularly from the CEO and CFO – carries more importance than purchases made by other officers, as they are considered clearer signals of future gains.
The market places strong trust in top executives’ buying decisions, believing them as votes of confidence in the company's trajectory.
On average, stocks see a 3% increase over 50 days and a 3.5% gain over 100 days after a CEO or CFO purchase.
Rule 4: Larger Trades in Undervalued, Small-Cap Stocks
The context is essential when evaluating insider buying's predictive power. Director purchases are more significant when companies’ stocks seem undervalued, especially small-cap and micro-cap companies.
In less-followed market segments, large institutions may struggle to trade in size, allowing insider purchases to have more noticeable impacts. Research by Lakonishok and Lee, who analyzed insider trades from 1975 to 2005, found that director buying was especially predictive for small-cap value stocks.
The researchers showed that substantial purchases by multiple insiders resulted in the highest returns, aligning with Stockopedia's research, which indicates that stocks typically climb by around 5% within the first month following a significant director purchase.
Combining insider buys in undervalued small-cap stocks with strong fundamentals (value, quality, and momentum) can further enhance the likelihood of success. In some cases, this approach has resulted in success rates exceeding 95%.
Beyond the Buy: Context Matters
While focusing on these insider buying 'sweet spots' enhances the odds of discovering promising investments, insider buys should not be viewed in isolation. To make the most of these signals, they should be integrated into a broader investment framework. Insider buying signals are most powerful when used alongside other analyses (such as fundamental strength, market sentiment, and macroeconomic conditions).
Stockopedia's StockRanks system, which evaluates stocks based on value, quality, and momentum, helps investors combine insider buying signals with other vital factors. By identifying stocks that excel across these areas and exhibit positive insider trading activity, investors can identify stocks with substantial potential upside.
Unlocking the Power of Informed Decisions
Understanding the motivations and actions of those with the most intimate knowledge of a company can provide a valuable edge. By focusing on buy signals, identifying cluster buying, prioritizing purchases by top executives, and seeking large trades in undervalued small stocks, investors can more accurately identify the 'sweet spots' in insider buying that truly matter. However, even the most compelling insider buys should be part of a more comprehensive investment strategy.
Combining insider signals with a deep understanding of company fundamentals and market dynamics, alongside tools to track and contextualize insider activity, can significantly increase the probability of long-term success.
- Insiders' purchases can signal optimism about a company's undervalued potential and growth prospects, as veteran investor Peter Lynch suggests.
- When multiple directors buy shares in a short time period, it's known as 'cluster buying,' and the average monthly returns are often 2% higher than the market's average.
- Purchases made by executive directors, particularly from the CEO and CFO, are considered clearer signals of future gains due to their access to sensitive operational and financial details.
- Director purchases in undervalued, small-cap or micro-cap stocks can have more significant impacts, as large institutions may struggle to trade in size in less-followed market segments.
- For the best results, insider buying signals should be integrated into a broader investment framework, combining them with analyses of fundamental strength, market sentiment, and macroeconomic conditions to increase the probability of long-term success.
