Pledging by promoters on the rise: Why investors should be bothered about this trend
Though the stock market is stable at present, some worrying signs like the jump in promoter pledges at the end of the last fiscal should not be ignored.
As on 31 March, 2015, there were 25 companies in which the entire promoter holding (100 per cent) was under pledge, 77 companies with more than 90 per cent promoter pledge and around 200 companies with more than 50 per cent promoter pledge. High promoter pledge can play havoc in a counter if the price continues to fall and we have seen instances like that in the past. "High promoter pledging will create a vicious circle whenever there is a correction in that counter," explains Hemant Kanawala, Head of Equity, Kotak Mahindra Old Mutual Life Insurance. Stripped off the jargon, it means that finance institutions will ask for more securities as margin from promoters when the prices go down. If the promoter obliges, the pledging as a percentage of promoter holding will go up and this may negatively affect the sentiments further. If the promoters can’t give more margins, the institutions may sell the stocks in the market to recover their money and this will result in sudden fall in price. A forced sell may result in change in management also.
Does this high share pledging pose a serious risk to the overall market? Not really. "Since the high pledging is mostly concentrated in small and mid-cap counters now, the risk to the overall market is miniscule," says Vivek Mahajan, Head of Research, Aditya Birla Money. The difference in the profile of players in the mid and large-cap counters has a large role to play. While the small-time punters are active among small and mid-cap counters, it is the institutions (domestic and foreign) that control the large-cap counters. "Broader markets are controlled by institutions and therefore, the fundamental reasons like earnings disappointments or global factors will be the reasons for corrections there," says Kanawala.
However, there are some large-cap companies (with a market cap of Rs.5,000 crore or more) in the list. For example, Suzlon Energy is among the top 10 companies with maximum pledges. It has 98.56 per cent of its promoters’ holding under pledge (see table). There are also nine large-cap companies where the promoter pledges are more than 50 per cent of their holdings.
What should investors do at these counters? One route is to stay clear of them altogether. "There are so many other good stocks in the market. It is better for retail investors to stay away from these stocks, especially where the promoter pledge is more than 50 per cent," says Mahajan. There are several reasons for this advice. Most companies with high promoter pledging are highly leveraged and don’t have sound cash flows. As mentioned earlier, there are technical factors also working against these counters. The promoter pledging will only make the counter more volatile. "Even when the fundamental is good, the corrections in these counters, whenever it happens, will be more. Investors need to be extra careful when the promoter pledging is high," says Kanawala.
Risk takers, however, can still invest in them provided they do proper research. Our advice to those investors is to study these "factors" before venturing out there.
First, check the reasons behind the share pledging. It is fine if the pledging has been done in the interest of the company. Sometimes, banks ask promoters to pledge their holding in the company to get project or working capital funding for the company. This only shows the commitment by the promoters to the company. And since it is treated only as additional collaterals, there is very little chance of banks selling these shares if the share price comes down in the open market.
However, investors should avoid the company if the pledge is for the promoter’s personal use. For example to invest in other businesses. Investors also need to take a closer look to find out who is pledging the shares—core promoters or someone in the distant family, who is also clubbed as pro-moters due to regulatory reasons. If it is not the core promoter, there won’t be any strategic incentive to retain the holdings and if the price continues to fall, the same share may come to the market for sale.