If directors are forking out, follow suit

Terry Bond: Keep an eye on directors' dealings and share buy-backs - they can be a green flag for investing

Having sat through innumerable board meetings, I've often dreaded the chairperson turning to us fellow directors and saying: "Come on guys and gels, time to put our money where our mouths are. Let's show solidarity and plough some more of our own funds into this company." Equally, I have always thought it must be difficult to reach consensus opinion in the boardroom on the proposition that a company should buy back its own shares.

Having sat through innumerable board meetings, I've often dreaded the chairperson turning to us fellow directors and saying: "Come on guys and gels, time to put our money where our mouths are. Let's show solidarity and plough some more of our own funds into this company." Equally, I have always thought it must be difficult to reach consensus opinion in the boardroom on the proposition that a company should buy back its own shares.

Certainly either scenario must cause pause for thought. It's all very well for directors to moan that their share price is undervalued, but there's a big step between this sort of whingeing and actually putting your hand into your personal pocket. And who wants to carry the can for having made a collective decision to buy back shares if the price subsequently plummets?

Small wonder then that there is increasing focus from private investors on directors' dealings, particularly if they buy in a cluster. Of equal significance, I believe, is a concerted programme of share buy-backs by a company and if the two activities are synchronised I begin to feel someone is waving a green flag at me. And when it happens in the present uncertain climate I get quite excited. I have a couple of shares for you to examine, using this kind of share transaction as a criterion, but first let us look at why it is worthwhile.

First, directors themselves buying shares (incidentally, buying is more significant than selling because the latter might have a completely unrelated reason, such as a tax bill or an offspring's wedding). It is important to check how many and how much. These facts are easily found via the news archives on the internet or in publications such as REFS (Really Essential Financial Statistics).

If a director already owns a million shares and buys an additional 5,000 it is of no particular interest. Or if a director is newly appointed and quickly buys a holding that is what he or she is expected to do and therefore not important to other would-be investors. If a director realises options that were granted at below today's price it does not deserve your attention, unless the person holds on to the shares, which indicates a belief that the price will rise.

But if a director who holds 10,000 shares increases his or her holding to 20,000 and pays the market price then take particular note. If it's the finance director, your pulse should really quicken because finance folk are notoriously cautious with their own cash. And, should a group of directors pay today's price for a major slice of shares, you might well consider joining them.

So what's so important about a company buying back its own shares? As far as I can see, it can only be good news for shareholders because it demonstrates:

The Board has confidence in the company.

The company has enough cash to make the purchases.

The number of shares is reduced (those that are bought back are cancelled) and therefore those that are left are worth more.

Company earnings are probably enhanced because using cash for this purpose can be tax efficient.

There is a school of thought - fallen idol Warren Buffett belongs to it - that if a company has spare cash it should be given back to the shareholders. Indirectly, this is what the company is doing when it buys its own stock because shareholders who want to retain their shares have a slightly bigger slice of the cake and those who want to take profits can cash in some of their chips.

Meanwhile ...

Now to the two companies that caught my eye this week during a perusal of directors' dealings and share buy-backs.

The first, Metalrax Group, has seen its share price slide by around 40 per cent since this time last year, despite a first-class performance history and confident forecasts from the Board. In the last six months the chairman, the managing director and the finance director, plus two of their wives, have been buying reasonable amounts of stock steadily but surely. And in March the company purchased 1.15 million of its own shares at 56.5p each.

When I spoke to the chairman, Eric Moore, on Tuesday afternoon he was fresh from the annual meeting of Metalrax. He had just reported record pre-tax profits of £14.23m, which is particularly creditable when considered against a background of the strife-ridden car industry, hitherto the backbone of the group's business.

"We've had a policy of reducing exposure to the automotive sector, although we still do good business there," said a confident Mr Moore. "Our sales volumes and operating profits are up across the board and everything is in line with our expectations."

Metalrax is in the business of metal forming (I recall from my time in the West Midlands it was called metal bashing) and after the £5.63m cash purchases six months ago of two cookware businesses it now has two divisions. Sixty per cent of the group turnover is still in engineering and storage products, which involves automotive engineering assemblies, tube manipulations, pressure die-casting and the manufacture of metal shelving. The addition of the houseware division means they also make cooking tins and other such kitchen objects. Contracts to supply major outlets have developed to the point where it is an important part of the business.

"We're selling in 60 countries and competing for business with German, Spanish and Austrian companies," Mr Moore told me. "And we are winning. Admittedly the pound is strong but that means we are able to buy components from abroad at the right price.

"It is all a matter of good housekeeping. We have great faith in this company and its future."

Metalrax has a dividend yield of 8 per cent, a price-to-earnings ratio of about 6, an excellent profit margin and a first-class return on capital. This week the shares were around 60p. No wonder the directors and the company are buying shares.

Next is Next. A few years ago I made quite a killing in the shares of this popular middle-of-the-road fashion store when a work colleague, a young lady in her early 20s, raved about Next's spring range. She assured me her friends were clearing the rails of clothes that were original and appealing.

This sort of sharp-end information is what an investor craves to hear because it means we have news of a sales boom before the City suits hear about it. I bought, and sure enough the popularity of the spring range translated into good trading figures, and a couple of months later the share price rose significantly.

I asked my colleague to give me an opinion every time a new season's range came into the Next shops and six months later she was not nearly so enthusiastic about the winter collection. I sold my holding and felt quite smug when the share price dropped.

A cosy profit like that means that I watch the progress of the company with affection, so in the share buy-back columns it was intriguing to note that in the month between 27 March and 27 April this year, Next announced no fewer than 16 purchase transactions totalling over 21 million shares.

The company has now bought back 10 per cent of its shares for £91.8m. Add to this act of faith the fact that earlier this year a number of the Next directors added to their holdings and you have an encouraging picture.

On Thursday, on the back of an announcement of a 10 per cent increase in turnover for the first 15 weeks of this year, Next shares were 615p and rising. That is an increase over of £1 in May, which is a considerable improvement, considering the state of the market generally and the retail sector in particular.