Promoter Pledge means the owner of a company takes a loan against his own shares.
The promoter could be pledging shares for various reasons – to meet the running capital requirement of his business, for personal needs or to fund new acquisitions.
In India, Promoter Pledging is considered to be a warning sign that the business could be in trouble in the future.
The problem arises when the stock price falls and the lender (bank) asks for higher collateral – which means, the promoter has to pledge more shares. When this happens, the news goes out into the market that the promoter has pledged more shares, the stock price falls further, the lender asks for more collateral. This can potentially turn into a vicious cycle for a fundamentally weak company.
Let’s take a simple example.
The stock price of a company is ₹ 100. The promoter pledges 50 shares, the value of which comes to ₹ 5000. The promoter takes a loan from the bank. Now, a few days later, the stock price falls to ₹ 80. The value of 50 shares which the bank has kept as guarantee (collateral), has also fallen to ₹ 4000. The bank asks the promoter to pledge more shares or they would sell the pledged shares in the market.
This could lead to the stock price falling further and the percentage of pledged shares increasing.
However, for a fundamentally strong company, pledging of shares up to 10-15% or a little more, should not be a problem – if the reason is valid.
When a promoter pledges shares of his company, it’s important to dig deeper and understand the reason behind the move.
The percentage of pledged shares is also very important. The lower, the better.
The promoters of ‘Asian Paints’ have pledged nearly 12% of their shares. Is it a cause for concern? Definitely not. It’s one of India’s top companies. They have huge cash reserves and their business is doing extraordinarily well too.
How to decide whether you should be invested in a company where the promoter has pledged shares?
Avoid investing in these companies:
- Avoid investing if the promoter of a lesser known company (small / mid caps) has pledged their shares.
- Put the name of the promoter in Google and include the word ‘scam’ or ‘arrest’ or ‘income tax raid’ along with the name. If there are news articles where the promoter has been suspected of scam or there have been income tax raids – avoid those companies.
- If a promoter has pledged very high number of shares, again, it’s better to avoid.
There are more than 5000 companies listed in the stock market. There are many companies that are clean with a strong promoter / management. Choose those. Do not try to earn quick money from bad companies.
How to check promoter pledged shares?
Visit MoneyControl.com from your browser, search for any stock. When you get to the page of the stock which you want to check promoter pledged shares, find Shareholding Pattern and click on it.
You should be see ‘Pledged’ right below Promoter row. The example below is of Asian Paints.: