Promoter Pledges: A Red Flag For Investing in a Share

by Manshu on October 23, 2012

in Investments

On Monday I wrote about debt recast, and one the two companies mentioned in the original comment requesting the post was Suzlon which reminded me of another post I had done more than one and a half years ago.

That post was about three things you should look at if you want to analyze individual companies, and share pledges was one of the three factors.

Promoters have to declare if they have pledged their shares and borrowed money against it, and this information is publicly available. This is a good thing to keep track of because you’d imagine that for a promoter, their shares are the last thing they want to borrow money against.

The way borrowing against shares works is that if you have shares worth Rs. 1,000, a lender may give you 30% of that value, and you have to maintain that margin which means if the shares fall in value then you have to either pledge more of them or come up with more money. If you fail to do that then you can even lose control of your company because the lender will seize your shares, and that’s a terrible situation to be in.

That’s why I consider a high promoter pledge a red flag, and if you combine that with low promoter stakes in the company then to me, that’s an even bigger red flag.

I did a list of shares with promoter pledges back in 2009 and Suzlon features there along with around 400 other companies. Suzlon is there with about 25% which is a high number and their share price today which has gone down about 50% in the last year which given the broader market is a fairly bad performance.

One factor alone doesn’t give you a conclusive answer on whether or not you should invest in a company, but if you want to invest in stocks then promoter pledges is certainly an important factor to keep in mind.

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{ 4 comments… read them below or add one }

Karthik Reddy Chintaparthi October 24, 2012 at 10:51 am

Manshu,

Do you recommend investors to stay away from Suzlon at current levels ? Is this another Kingfisher in making ?

Thanks,
Karthik

Reply

Manshu October 24, 2012 at 5:18 pm

It has been a general rule of mine to stay away from stock specific advice on this blog.

Reply

Rohit Varma January 20, 2013 at 10:05 pm

Hi Manshu,

Hope you are doing good… Is it a standard wherein you will get 30% of the share value or this value can be anything

Reply

Manshu January 20, 2013 at 10:09 pm

I’m doing fine Rohit, thanks for asking.

30% is just an example that I took, in practice it may be higher or lower than that.

Reply

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