DECODING STOCK MARKETS

Pledging of shares by promoters: How it matters

In India, promoters are the majority shareholder group that

manages the day-to-day affairs of a company. When they need
money, very often, promoters of listed companies pledge all or
some of their shares with lenders. It means that these shares are
offered as collateral to banks in exchange for loans. This is one of
the many sources of borrowing money, especially in a volatile
market with tight liquidity conditions.

Here are few things to know about the implications of pledging of

promoter shares:

Pledging of shares is common in companies where promoter

holding is high. While pledging shares, ownership is retained by
promoters. In a rising interest rate scenario, promoters often use
shares owned by them as collateral for loans. If the majority
owner in your company has pledged a sizeable chunk of his or her
equity, it could trigger a volatile price movement in a falling
market.

Shares of companies with high pledging of promoter holding tend

to witness volatility. The Reserve Bank of India, in its latest
Financial Stability report, flagged a concern over pledged shares.
“Pledging of shares by promoters could pose as a concern in both,
falling or rising market scenarios, when large scale pledging of
promoter equity could pose concerns for retail investors’ wealth,”
the RBI report said. As a result, investors need to look at pledging
of shares by promoters before buying stocks.

Higher the pledging, greater could be the risk of volatility in the

company’s share price. This is because, as share prices fall, the
overall value of the pledged collateral falls. This would put
pressure on the promoter to produce more assets as collateral.
Sometimes, the lender may also be forced to sell some of the
shares to ensure that the loan does not turn into a bad loan. If the
promoter is unable to meet obligations of borrowing, the
ownership of shares is transferred to the lender, who may then
sell it to recover loans.

In India, out of the over 5000 listed companies, promoters of 4274

companies had pledged all or some of their shares, according to
an analysis by Securities and Exchange Board of India. This was
quoted in the recent RBI Financial Stability report. Of these,
promoters of 286 companies had pledged more than 50% of their
shareholding. Nearly 90% of these companies belong to the small-
cap category.

Pledging of promoter shares witnessed its highest quarterly jump

in three years in June 2013 quarter. During an economic slowdown
and rising interest rates, banks could put strict conditions on
borrowing.

Risk is calculated on the basis of the amount of pledged shares as

a percentage of the total shareholding. When the shares pledged
exceed 50% of the total shares of the company, the company falls
in the high risk category. 48 companies belonged to this category,
according to the RBI report. As many as 154 companies fell into
the medium risk category with pledging of 25-50% of promoter
shares.

Shareholding Pattern Analysis :- Importance, significance and

effects on stock price

Purchasing a stock is nothing but to become a partial owner of the

business. As a partial owner you need to consider the other
investors on that business. Shareholding pattern tells us the
detailed ownership of that business. Most importantly many a
times, shareholding pattern indicates future stock price
movement. The following article will discuss the significance of
shareholding pattern,how it affects shareholders and stock price
movement

Broadly shareholding pattern is divided among two groups –

Promoters and Promoter Group- Promoters are those who

incorporated the company. They can be either domestic or
foreign. Relatives of promoters owning shares also come under
promoter group.

Public Group- Share holders other than promoters constitute

public shareholding pattern. FIIs, DIIs, banks, money managers,
mutual funds, insurance companies, individuals, etc. come under
this group.

Companies or individuals other than the promoter group holding

more than 1% of the total share capital needs to disclose their
details. We will now analyze the consequences on company’s
performance based on the actions of the share holders. Before we
continue further, remember, shareholding pattern in isolation is
not sufficient enough to take any investment decision.You must
have to consider other factors along with shareholding pattern.

PROMOTERS SHAREHOLDING PATTERN AND ITS SIGNIFICANCE:-

Promoters are the founders (or initial investors) of the company.

Promoter holding is the total number of shares held by the
promoters and the promoters group out of the total outstanding
shares of the company. SEBI recently introduced a regulation that
maximum percentage of promoters holding will be 75% of the
total shareholding. This means that public holding will comprise
minimum 25%.

Generally, promoter’s movements are followed to predict the

future outcome of the company. If a promoter raises his stake, it is
comprehended that he has high confidence in the business and
may get positive results. But this does not always hold true

Let us consider an example. Promoters of Everonn Ltd increased

their holding from 42% in September Quarter 2011 to 55% in
December Quarter of same year, but the outcome was quite
disappointing. So investing solely on this basis can leave you
disappointed. Many at times promoter simply buy more share to
boost the stock price. Therefore, it does not at all mean that
buying always is associated with good prospect and expected
profit. However, most of the time increase in stake is followed by
the upside movement of the company.

Now, what if the promoter holding is low or promoters are selling

their share? Lower stake means low confidence in the company
i.e. the promoters are not optimistic about the future prospect.
Like it happened in case of Satyam Computers. Who can forget the
Satyam Computer scandal? Total shareholding of promoters and
their group was 10.70%, while the total public shareholding was
89.30% by the end of June 2008. It reduced to 2.70% and total
public shareholding tolled to 97.30% by the end of 2008.
Following this share price plunged by 77.7% on January 7, 2009. In
this case promoters knew that they had forged the accounts and
with the exposure of forgery, shares would experience plunging
and it happened also.

But always we can’t intercept the offloading as the negative thing.

The reason behind this is that even they have the right to enjoy
the profit of their company. It is nothing bad in it if they sell some
part of their stake after the company posted huge numbers on
board, moreover they came in the business to earn money and
they have been working for it since 10-15-20 or even 50 years!!!
For an example , promoters of Page Industries are reducing their
stake during the last 2-3 years. Still the stock price appreciate
more than 200% during the last 2-3 years.

PUBLIC SHAREHOLDING PATTERN AND ITS SIGNIFICANCE

Share holders other than promoters are known as public share

holders. Public shareholding pattern consists of institutional and
non institutional investors.

Institutional investors–

Institutional investors include the pension funds, money

managers, mutual funds, insurance companies, investment banks
and commercial trusts. They buy large quantities of shares leaving
high impact on the stock market’s movements. They are
considered knowledgeable and experienced. Hence, their
footprints are generally followed by small investors.

Non-institutional investors–

Non institutional investors are those who carry their investments

through a broker, bank, real estate agent and so on. They are
generally common people or organizations managing money on
their own.

Institutional investors are of two types- FII and DII –

Significance of Foreign Institutional Investors (FII)

Foreign Institutional Investors are considered as the darlings of

the company. They are the drivers of the market. They are
considered as smart people investing their smart money.

A higher FIIs stake is interpreted as positive and a lower FII stake

means low confidence of FIIs in the company. If FIIs increase their
stake it is considered positive as they invest funds only when they
are totally optimistic and confident about the future of the
company.

Just like promoters, If FIIs sell their shares then it does not mean
that the company is fundamentally weak. Their selling may be due
to the economic or political changes, legal problems in their home
country or it’s just that they want to enjoy their profit. What ever
be the reason, if they offload huge quantities then a huge fall in
stock price is witnessed.

Key to earn multi-fold return from stocks :-

The key of successful investing is to identify a stock which can

become favorite among FII in near future. In such case stock price
multiplied by 3-4 times or more within 1-2 years. For an example,
we had recommended Ajanta Pharma at Rs-252 during
December,2012 to our paid clients. Back then, the stock was not
covered under big brokerage house. The company didn’t get
enough attention from institutional investors.Slowly, with
improved fundamentals, strong financial numbers and better
future outlook, the company attracted institutional investors.
Since December,2012 to till date(Mar,14) FII increased their stake
to 3.81%, resulting an increase of around 184% on FII holdings.
No, wonder, since our recommendation the stock price generated
around 460% return (more than 5 times) for our members within
2 years.At the time of writing this article the stock price is at Rs-
1424. So, you can make wonder if you can invest in a stock before
it attract heavy investment from FIIs (or institutional investors)

Significance of Domestic Institutional Investors (DII)

Domestic institutional investors are those institutional investors

which take on investment in the same country they are settled in.

Institutions or organizations such as banks, insurance companies,

mutual fund houses, etc in the financial or real assets of a country
comprise DII.

Like said earlier money managers are knowledgeable and

experienced who keep an eye on every activity of the stocks. So,
they choose the company based on minute analysis and careful
observations. Hence, if DIIs invest in any company, it is considered
as a good sign.

Buying and selling huge blocks of share causes fluctuations in

share price. Many at times offloading is done due to various
reasons like pressure by their clients, political uncertainty,
economical constrains etc..

Significance of Individual Investors

Individuals like us are many in numbers even lakhs and crores

forming a part of shareholding pattern. But stock prices don’t get
affected by our transactions as shares owned by us is very small
when compared on the whole. You need to be careful if you find a
stock where individual shareholding is increasing while decreasing
promoters/institutional shareholding. This may be an early sign of
stock price crash. Individuals have the least amount of knowledge
and mostly carried with emotions. On the other side, institutional
investors are the most knowledgeable (after the Promoters). So,
you should be cautious if increasing individual shareholdings is
resulted due to significant decrease in institutional holdings.

So, this was the understanding of shareholding pattern and its

significance. It is mandatory to analyze the shareholding pattern
in-depth before any investment especially about promoters
because it is rightly said a good management can uplift a bad
company and a bad management can ruin a good company.