Watch out for pledged shares; they're key to a company's health

Sep 02 2013, 08:12 IST
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Cos with high amount of pledged promoter shareholding are susceptible to erosion in stock prices. Cos with high amount of pledged promoter shareholding are susceptible to erosion in stock prices.
SummaryCos with high amount of pledged promoter shareholding are susceptible to erosion in stock prices.

Mallya against money lent to Kingfisher Airlines. The bank moved to do so after the airlines failed to repay its loan.

Also in a falling market scenario, like the one we are in now, if the share prices fall below a certain limit then the promoter is required to provide additional securities or make some payment.

“Companies with a high proportion of pledged promoter holding are susceptible to such erosion in stock prices,” said Pankaj Pandey, head of research at ICICI Securities.

Stay away from such companies

Valuation trap is something that investors may easily fall into when it comes to these companies. A number of these companies are trading lower as a result of a decline in their share prices but these companies may not be adding much value to their equity shareholders. While their interest outgo would be in double digit, experts say that their growth may be in single digit and therefore while their share prices may appear to be lower and available at cheaper prices, they may not bring value to the shareholders.

Also, at a time when the Reserve Bank of India has taken measures to tighten the liquidity and the US may begin tapering of its quantitative easing programme in September, liquidity situation may further tighten making things even more worse for some of these companies.

“In a situation like this, investors should avoid such companies,” said Pandey. Parikh advises investors to go with companies that have good cash flow and have low debt-to-equity ratio in these times when liquidity is likely to remain tight and companies that are heavily leveraged may come under pressure.

“Till the current environment prevails, such companies will find it increasingly tough to maintain their margins and therefore investors should stay away from them,” said Parikh.Investors, however, need to check on various details of the pledging before they get into the stocks.

“If the pledging is less, up to one-third of the promoters holding and has been done for purposes linked to core business, then there is not much of an issue. But if it has been done for other purposes and the shares have been pledged with NBFCs who charge a higher rate then investors need to be careful,” said Gaurav Dua, head of research at Sharekhan

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