Investors turned wary of companies with high pledge shareholding after promoter of Essel Group failed to bring in fresh shares as collateral to make up for the stock price crash. The shares of Zee Entertainment have plunged more than 20 percent so far in January.
On January 25 itself, the stock fell more than 30 percent on an intraday basis, and 26 percent on closing basis.
Shares of Adani Group companies also came under selling pressure earlier this week largely on worries that the promoters’ share pledge with lenders was high.
What are pledged shares
Before we go further, let’s first understand what are pledge shares?
It is a loan taken against the shares which promoters hold. This is one of the means by which promoters can raise funds which could be used for multiple purposes.
Can the lender sell pledge share?
Yes, the lender or the bank can sell shares if the value or the price of the stock falls closer to the value agreed in the contract between the lender and the promoter because these shares are treated as collateral for the funds taken.
Promoters of 195 companies on the BSE have pledged more than 50 percent of their shares, according to data provided by Prime Database.
“There are concerns regarding companies where promoters have pledged their shares. Fear psychosis has gripped market participants and anything to do with corporate governance is instantly sold into,” Dharmesh Kant, Head of Retail Research at IndiaNivesh Securities told Moneycontrol.
“The recent spate of events, be it the IL&FS fiasco, DHFL, Yes Bank or PNB, justify wild reaction by markets,” he said.
Other companies with high pledged shares by promoters include Sterlite Technologies, GMR Infrastructure, Apollo Hospitals, Reliance Power, JSW Energy, Coffee Day Enterprises, Dish TV India, Reliance Capital, Reliance Power, Future Consumer, Indiabulls Real Estate and Max Financial Services.
Here is a list of 20 stocks with the highest value of pledged shares by promoters from the list of 195:
Promoters pledge their shares either for capital requirement for business or for a personal reason including other investments. But, the lender has the authority to sell the shares in case promoter fails to meet the margin call.
A margin call is triggered when the market value of shares is less than the amount lent by lenders.
“Suppose a promoter pledges ‘X’ no of shares and the stock price declines, then promoter has to face a margin call and may need to give further margin by way of additional shares,” Atish Matlawala, Sr Analyst, SSJ Finance & Securities told Moneycontrol.
“If the promoter fails to submit the money then the lender will sell some shares in the open market which will lead to further fall in share prices; thus creating a vicious cycle,” he said.
As many as 96 companies that have declared their pledge share holding for the quarter ended December show that companies with high pledged holding have seen a steep decline in 2018.
As many as 15 companies out of 96, which declared their pledged earnings data, have fallen up to 80 percent since 2018 till date. This includes Atalanta, Parsvnath Developers, DB Realty, Omaxe, Coffee Day Enterprises.
Should investors stay away from companies with high pledge holdings?
Ideally, investors should stick to companies with sound fundamentals and stay cautious on companies with high pledge holding. Although, this is general practice but could become risky for retail investors if the lenders start selling shares in the open market.
But, if the company has increased cash flow and good future prospects then pledging can help in the expansion of the company which could, in turn, result in high cash flows.
“High pledge share does not necessarily mean weak fundamentals. If the company has increased cash flow and good future prospects then pledging can help in enlargement of the company and will help the company to carry out new projects which will ultimately result in amplified future revenue,” Ritesh Ashar, CSO, KIFS TradeCapital told Moneycontrol.
“If the company has a good amount of cash flow and the future prospect are promising then the pleading won’t affect the company. But, high pledging of shares can result in a disaster for the retail investor if the lenders start selling the shares in the open market. Pledging of shares indicates the weak cash flow of the company and its inability to meet the short term requirements,” he said.
Kant of IndiaNivesh Securities says that high pledge always raises doubt on fundamentals being strong. Strong business has sufficient cash flows so pledge is not required. “The very fact that pledge is required raises concern. However, on a case by case basis, the prudence of pledge is judged,” he concluded.
Disclaimer: The above report is for information only and not necessarily buy or sell ideas. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.