How to Analyze Shareholding Pattern and Promoter’s Pledge

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Shareholding pattern in a company has been a major point of discussion among analysts and investors in the last couple of decades. There are different theories and methods used by investors to interpret the shareholding by different classes of shareholders and patterns of change therein. In this article, I’d try to help you by telling you what I feel is the best approach to go about analyzing the shareholding of a company and pledging of their shares by promoters.

 

SHAREHOLDING PATTERN

Shares of a company may be held by different groups of shareholders. Every quarter, each listed company needs to disclose its shareholdings divided into the prescribed sets of shareholders, within 21 days of the last day of the quarter. These shareholders can be divided into two main groups – promoters and public shareholders. These two can be further divided into many subcategories. Instead of going into details about each of those, it would be better to discuss those that can have an impact on your investment decision.

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Promoters

A high promoter holding is a sign that the promoters have confidence in their management and the prospects of the company. Promoters are also shareholders and if they are apprehensive about their company’s future, they’d rather sell their shares. When I am looking for mid-caps and small-caps I generally avoid companies having less than 40% holdings by promoters (also taking pledged shares into account). A high promoter holding gives more comfort to an investor regarding the company’s stability in the future. I do not generally look at the shareholding percentage in large-caps as these are huge entities that need funds from outside and so they might have low promoter holdings.

In addition to the company’s promoter holdings, the pattern in which the promoters’ holdings have changed over the last few years should also be considered. The first people to know about the future of a company are their promoters. If the promoters have bought their company’s shares, it can only mean one thing – they know that the company will do well in the coming times. This is one of the major points mentioned by Peter Lynch in his book One Up on Wall Street. If you see a pattern in which the promoters have gradually increased their holdings, you should give that company some extra weight when comparing it to others.

Having said that, if a company’s promoter holdings have been decreasing, it may or may not be a bad sign. A promoter might be selling because he needs money for personal reasons. Who knows? But if the promoters are offloading their shares regularly or have offloaded a large chunk of their holdings, it might be a matter of serious concern and may well point to a possibility that something is amiss. Investors should stay away from such companies.

In short, although insider trading is strictly prohibited (and rightly so), the shareholding pattern of promoters can divulge significant insider information, though not explicitly, but in the form of a general idea.

FIIs and Mutual Funds

While there is a consensus among analysts regarding the interpretation of promoter holdings in a company, institutional holdings is still a subject of disagreement. According to one school of thought, a high weightage of holdings by institutional investors and mutual funds in a company’s shareholding indicate that they trust the company and believe in its future prospects. Since these institutions invest their funds only after a lot of due diligence, their calls are generally expected to be correct and they are expected to hold their investments for a relatively long period of time.

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But there is another group that says that huge institutional investments make a stock vulnerable. Who knows when these institutions decide to get rid of their holdings? And whenever that happens the prices of that stock is sure to come tumbling down. This leaves the stock at the mercy of their institutional shareholders. This is the reason why Peter Lynch warned investors against investing in companies having significant holdings by institutional investors.

Institutional investors generally focus on just the top 400 to 500 companies out of the 4500 listed companies. This I believe leaves a whole world of opportunities unexplored. I treat this as an opportunity to find hidden gems and beat the institutions in their own game. So what should you do? I simply ignore the institutional holdings when making my investment decisions. There is no clear evidence suggesting any clear winner between the two views given above. I have seen cases that favor both views and after a lot of trial and error, I decided long back that I will not be too bothered about this factor. And I suggest the same to you.

PLEDGING OF SHARES

Shareholding by promoters should also be seen in the light of the proportion of holdings pledged by the shareholders. When promoters need money, they often pledge some or all of their shares with moneylenders. These shares serve as a collateral. Too much pledging tends to make the share price volatile. In a bear market, the stock prices may fall reducing the value of the collateral. The lenders, in such situations, put pressure on the promoters to present more collateral. If the promoter fails to repay the loans, the lenders may sell the shares to recover their money, resulting in a big fall in the share prices.

Pledging of shares by promoters has become a very common practice in India to raise loans. If the promoter’s holding in a company is significant, say around 70%, a pledging of 20% of those shares shall not be a cause of too much worry. But what if the promoters hold only 40% of the share capital of the company and have pledged 60% of their holdings? That would be a serious concern for me.

The best way is to look for company’s having an unpledged promoter holding of 40% or more, especially in case of small-caps and mid-caps. This may help saving investors from possible capital erosion in the future.

Again, the pattern of stock pledging should also be looked at by the investor. If the promoters are regularly increasing their pledged percentage, they may be up to something. Investors should better be safe and stay away. Why get yourself into a possible mess when there are safer options available to you?

Recommended: STOCK INVESTING: MUST-HAVE FEATURES TO LOOK FOR IN A COMPANY

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