10 Dangerous Stocks in a Bad Market

I still remember that period in early 2009 when not a day passed when a listed Indian company did not came out in the open to disclose the pledging of shares by its promoters.

Ultimately, the debate wasn’t centered around which promoter had pledged his shares to raise funds, but rather on who hadn’t disclosed this information to the stock exchanges.

Also, as the count of companies disclosing pledging increased, so did the number of investor queries that I handled.

People got so worried hearing reports of pledging from the promoters of companies whose shares they held, that many sold off their entire holdings just out of fear.

After all, but for a handful of them, virtually every promoter of India Inc.’s leading companies was admitting to pledging shares for many years in the past.

Is share pledging good or bad?
“Should I sell my shares since the promoter has pledged his entire shareholding?” asked some investors.

“Is pledging good or bad?” asked others.

My answer, “It depends.”

There have been two popular end-use of the funds raised through share pledging:

1. To increase the promoters’ stakes in their respective companies, or
2. To give additional guarantees to financiers (especially banks) for loans taken.

If the intention is former, share pledging is not to be feared of. The argument here in favour of promoters is that they know what is best for their companies.

So, when pledging their shares, they will be careful about not getting into a position whereby they lose control of the company.

Also, the funds they’re borrowing are supposedly for their companies’ better future – either for an expansion or to fund an acquisition.

However, if the need to pledge shares is to provide additional guarantees to banks for loans taken, you must be very careful.

But whatever is the intention – good or bad – the flip side of promoters’ apparent eagerness to create shareholder value by borrowing against their shareholding is that the exercise is fraught with danger.

This is particularly true in a falling market, when the value of their pledges can fall drastically and the lenders may ask for more shares.

Also, in a falling market, if the bank decides to sell the pledged shares if the stock falls before a certain level or if the promoter is not able to bring in additional shares, it adds to the pressure on the stock’s price.

So, all in all, when you look at share pledging and before you form a view whether it is good or bad, first understand the intention of the promoter behind doing so.

And to understand the intention (which is indeed a difficult thing to gauge), look at the past track record of the promoter in terms of fund raising and shareholder value creation.

If the promoter has been reckless in the past when it came to raising funds for mindless expansion, there is no reason to believe that he will not be reckless this time around. Simply stay away from such companies.

However, if you believe the promoter has been disciplined in the past and is shareholder-friendly, keep your faith and don’t worry much about the pledging.

By the way, here are the top ten companies from the BSE-500 index where the promoters have pledged the maximum amount of their shareholding.

You know for a fact that some of these companies have indeed been irresponsible in the past. The high levels of pledging just add to that recklessness.

10 companies with highest pledging of promoter holding

Source: Ace Equity, Safal Niveshak Research
Click here if you can’t see the table above
Also, here is a chart that shows the number of BSE-500 companies with different levels of promoter pledging.


Source: Ace Equity, Safal Niveshak Research
Promoters of almost one-third (or 168) of these 500 companies have pledged some of their shareholding. And there are 36 companies where the promoters have pledged more than 60% of their holding.

As I said above, whatever is the intention, share pledging can come to haunt promoters and investors when markets take a nosedive.

Since markets are in a correction phase as of now, watch out if the promoters of the companies whose stocks you hold have pledged their shareholding. And if you hold any of the above 10 stocks, be extra careful.