Should the promoter’s percentage of pledged shares impact your buy or sell decision?

The word ‘Debt’ has begun to ring alarm bells in investor’s heads and not surprisingly so. Debt was always considered a seemingly harmless financial animal but has recently revealed some completely different colors.

Pledging of shares is another avatar of debt that has been waving a red flag lately. While it is a legitimate commercial activity to borrow money to fund a business, the problem occurs when promoters pledge their shares and invest the proceeds in unrelated financial assets,which eventually go sour.This could result in forced liquidation of the stocks by lenders, which results in loss of value for other unsuspecting stock holders.

As on July 30, 2019, the shares of 828 companies are pledged and this pledge value stands at around Rs 1.9 cr.(Source BSE)

In recent times,the markets have punished stocks that were over leveraged on the debt side, bringing into focus the percentage of promoters’share pledging activities and the company’s debt profile.

Even SEBI, the market regulator, on June 27,has put stricter norms for pledging of shares. It mandated that where pledging of promoters' shares is more than 20% of the total share capital of the company or 50% of the total promoter holdings, the promoters shall be required to disclose detailed reasons for encumbrance, separately.

As on July 30,here are some companies with a high pledge percentage.

Does that mean that one should exit stocks that have high promoter pledging of shares?

No, not necessarily. One has to check the promoter note on why the stocks have been pledged. If it is for business expansion/capacity expansion and a robust plan is outlined, then it may mean that the business is in good hands. Naturally, it may not make sense to exit from such stocks; rather, it could be an opportunity to invest. However, if the justification is not satisfactory, it would be best to avoid/exit the stock.

SEBI’s intervention by asking promoters to disclose the reason for pledging is very positive, as it would enable investors to make more informed decisions. Also, it will require promoters to be more disciplined in their investment decisions.

Now, the question could be, should one buy stocks where the promoter’s pledged stocks are revoked/reduced?

As per data from the NSE, promoters’ pledged shares have reduced in 45 companies and seven companies have reduced their pledged shares to zero in June 2019. These included Sterlite Technologies, Mangalam Drugs & Organics, Himatsingka Seide, Indiabulls Real Estate, Indiabulls Housing Finance, Byke Hospitality and Cigniti Technologies.

The fall in pledge holding is usually a good sign that suggests improved borrowing capacity or a value proposition on a long-term basis. It usually indicates confidence of the promoter in the business and suggests that the company could offer value at large over a longer time frame. But one should also consider other parameters like cash flows, debt, efficient use of capital and business prospects

To sum up, high levels of pledged stocks may not always be a red sign. But one needs to take enough precaution and go through the management note on the pledged stocks before deciding where you stand.  Similarly, a company that revokes the pledge could be a good buy, but one must revisit the balance sheet and cash flows before taking any decision.

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Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.