Know why pledged shares are bad for investing?

pledged shares bad for investing

It is always better to be a spectator initially rather than directly jumping into a game. And this game makes you or breaks you by infusing your time and money. Yes, this is the stock market and it needs your attention. 

In this article, we will make you aware that why pledged shares are bad for investing and to how much extend it is good to stay invested in the pledged shares. But for diving into a deep lesson let us first understand what is pledging of shares? 

What is pledging of shares?

The pledging of shares is a condition in which the promoters of the company borrow funds from the financial institutions by keeping some percent of their stake in form of shares with the lending company. It is as simple as getting a loan from a bank by giving them collateral in form of security.

And the collaterals are in the form of shares own by the promoters. The funds that are obtained by the promotors of a company can be used by them for paying off the debts, expanding the business positions, or carrying out current capital requirements. 

As we are aware of the fact that the value of the shares are not stable and they keep on fluctuating. So, how the promotors and the banks maintain rigidity with the amount borrowed and pledged shares. For instance, the promoters have pledged 1 Lakh shares for Rs. 1 crore, and at the time of pledging the value of a share was Rs. 100/ unit but if it falls to Rs. 90/unit so the promotors have to pay them the additional amount of Rs. 10 Lakhs or worth shares for maintaining the shortfall.

And sometimes to maintain a big shortfall the promoters sell their shares in the open stock market that ultimately reduces the market value of the share. And sometimes even without selling the shares in the market, opening up with the news that promoters have pledged shares creates a panic among the investors. Due to which the investors sell heavily and eventually reduces the market value of stocks.

Generally, if the promoters are involved in the pledging of shares and they have pledged around 50% of their stake then this is a frightening situation for the investors. And they should be exiting the company at the right time for securing the invested money. To make the right decision one must be an active viewer of what all is happening and why the promoters are reducing their stake.

Why pledged shares are bad for investing

We all know that generally most of the stake for a company is owned by promoters of the company. And the company with more than 50% of the promoter's stake is considered an ideal holding percent. For instance: If you own a business and are very optimistic that the company is growing and will keep on growing in the future as well. Then you will maintain a good stake in the company for getting more profits. On the other hand, if you not bullish on your business then you will reduce your stake in the business.

That reduction in the stake gives an intention to the investors about the promoters viewpoint for his own business. Similarly, the concept of rising or decline in the promoter's stake spotlight the concern of why pledged shares are bad for investing?

If a large portion of the shares is pledged then it depicts that the business does not have good liquidity of funds and poor cash flow. This also indicates that the company is facing debt issues and in the long run, this will cause a huge impact on the performance of the business if it is unable to pay off the debt amount. So, all in all, it is good for the investors to stay away from the businesses that have pledged a large stake with the financial institutions to fulfill their fund requirements.

The pledging of shares is a sign of trouble for the investor and one should try to square off the investment landed in the company if already invested. And try to avoid the pledged shares if one is willing to prop money in a certain business.

How pledging affects the investor's interest?

One should be aware and cautious about the companies that have pledged their stocks. And also to protect the interest of the investor's certain websites are available online that can aware you of the companies that are involved in this type of arrangement. Also, some of the online broking firms also maintain a record of such companies to assure their clients before landing their money in some company. Now, let us jump to the point that how pledging affects the investor's interest. 

An investor obviously desires to get great returns out of their investment and a heavy pledge of shares creates a panic scenario for the investors. Ultimately, people will try to reduce or fade their stakes in the company. Due to which the current market value or the stock price will decline.

Take Away

If you want to make an investment decision, make sure that there is no or minimal pledging of shares by the promoters of the company. The companies with the pledged shares do not always mean that this business is not worth investing in. As sometimes it is done to meet short-term financial needs or to elevate the business position.

But, the motive of this article to make the investors a bit cautious and aware of what is pledging and why pledged shares are bad for investing. If you are bullish on a specific company and confident that it will heal the pledged wound in the future then you should make your investment keeping the risk in mind.