Management signalling you should sell?
There are a number of indicators that investors use to assess whether to buy or sell a share. Some of the classics are:
share buybacks; and
management purchases of shares.
The basic idea behind these being indicators of value is that insiders — management — believe the share price is undervalued, so they use their tools to increase value for shareholders. Under classical theory a share buyback is used when management believe their share price undervalues the company and, in the long-term, cash resources are better employed by buying-in undervalued shares for cancellation than investing in assets for shareholder growth. In other words, management believes the company is undervalued. Management purchasing shares is also a classic indicator that management believe the company is undervalued - for obvious reasons. However, in smaller companies with less liquid shares, there may be something else going on that the casual investor should be aware of: these two activities could be an indicator that a well-informed quasi-insider is seeking to exit the stock, threatening to dump the shares on the market and, at the same time, is being highly critical of management being overpaid.
In a smaller company with less liquid shares, a material shareholder seeking to exit can cause a major share price fall whilst the market seeks to digest it. One of the very real jobs for executives of listed companies is to build demand on the stock market for their shares so, if there is a forced seller, there are buyers waiting for these shares. If a seller comes to the market that holds a material block of shares, the company’s brokers will often ask management to present to new shareholders. If management do this, and they cannot convince new shareholders, then the conversation tends to change colour. The brokers, who have put shareholders into the company’s stock and do not wish the price to fall, will start to put pressure on the company to use its own cash resources to buy out the exiting shareholders and hold the share price up. The other place that the brokers will apply pressure is to the personal accounts of the executives, particularly if the executives are seen as being overpaid.
What initially looks like a buy signal can sometimes be a sell signal:
share buybacks can happen where an institution wants to sell its holding but there is no market support - new professional investors cannot be found to provide the liquidity in the market (professionals don’t believe management), so pressure is put on the company to provide liquidity for the position;
the company recognises that it cannot use its cash resources to provide better returns internally for its shareholders;
management may be overpaid (look for management being paid bonuses in major loss-making years); and
all of this implies professional incoming shareholders have not got confidence in the company.
So be careful of trading on classic buy signal in smaller companies… there may be problems lurking under the surface that professional investors recognise but private investors have not got the experience to navigate.