Should I buy a stock where the promoters have pledged the shares?

Should I buy a stock where the promoters have pledged the shares?

(As per NSE Data, 1462 companies have pledged their shares for Rs. 7.03 lakhs Crore)

Remember the good old days of Big Bazaar, owned by Future Retail Limited?

Back on 14th February 2020, their stock was trading at a healthy ₹375. Little did investors know that within just 45 days, the share price would plummet by a staggering 80% to ₹70! (Now trading at Rs.2).

Here’s what happened:
The promoters held a 47% stake in the company, out of which a 50% was pledged to financial institutions as collateral for raising funds.

Now, these financial institutions typically lend money at 1.5x to 2x the cover value based on the internal credit policy, with a clause allowing them to sell the shares in the open market if the cover falls short.

On 15th February 2020, a negative news piece triggered a lower circuit for Future Retail’s stock. This was the beginning of the end.

All the lenders who had extended loans against the pledged shares started offloading their holdings to recover their money.

In such events, stock liquidity dries up, making it a 40-45 day process for the lenders to complete their sell-off.

Adding to the chaos, SEBI imposes various trading restrictions during such episodes.

The moral of the story? Investing in companies with high promoter pledging can be a risky proposition.

A single negative event like yesterday (where Nifty 50 fell more than 5%) can set off a chain reaction, leading to a dramatic fall in share prices and erosion of investor wealth.

So, the next time you come across a company with pledged promoter holdings, tread cautiously.

Understand the risks involved and make an informed decision aligned with your investment goals and risk appetite.

Sources

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