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Pledging of shares is one of the primary factors to be considered while choosing a stock to invest in, which many of the investors fail to observe. For stakeholders, high pledging of shares would be a concern. Pledging can be defined as taking loans against the shares that one owns, where share is scrutinized as a kind of asset. A Number of users have stocks, mutual funds and ETFs in their valuables with only limited cash margins, which make them lose trading opportunities. They can pledge their ETFs/Shares for security margins, which you can acquire after x% subtraction called ‘Haircut’. Any organization or individual who holds shares can pledge them. The main purpose behind pledging is; to get a bank loan and to fund their trading activities. It is utilized to fulfill various requirements such as funding other ventures, operating capital requirements, paying debts and more. Let us know more about Pledging Share and its working in this article!
What is Pledging Shares?
Pledging of shares is an organization where the promoters of a company utilizes their shares as security to satisfy their financial requirements. Pledging of shares has been quite seen in companies that have large shares owned by investors. The purchaser of pledge shares holds proprietorship of the assets and proceeds to receive interests and capital gains from those shares. However, the utility of shares keeps varying; the value of bond changes with variation in the market value of the pledged shares. The proponent is responsible to maintain the value of the proprietorship. The minimum bond value is fixed at the time of contract, even if the worth of the pledged shares drops below the amount secured, then the purchaser should give additional shares or pay cash to compensate for the drop in bond. The banks or granters are also allowed to sell the pledged shares in the unfolding, in case the purchaser fails to repay the collateral value. The pledged will be disoriented if they sell in the open market, which will lower the shareholding of the promoters and thus the stock value will get reduced.
How does Pledging Share Works?
The promoters can pledge their shares to keep away from trade opportunities lost due to low cash margins. After the withdrawal of the haircut, they can obtain a loan. The security margin earned from these pledged shares can be utilized for equity trading, futures etc.
Why Pledging of Shares?
Promoters pledge shares to fulfill their various requirements. Commonly, pledging of shares is the last option that promoters adopt in order to lift funds. It is always safer to raise funds by endowing debt or equity than pledging shares by the promoter. If one chooses to pledge shares, this means all other options are not valid for him to raise the fund. Usually, a company chooses the option of pledging shares when they are in need of immediate funds. Pledging of shares is a better option when the company’s performance is poor due to riskiness or poor history.
Risk in Pledging of Shares
In some cases pledging of shares becomes risky. The ‘pledgee’ or the fund issuer can retrieve the dues in case of non-remittance. Pledging of shares becomes messed in following situations;
- Bull Market vs Bear Market: During Bull market period, pledging of shares may not become cautious for the investors. But promoters should be aware while pledging large shares during the period of Bear market. Usually, supporters use their shake as a security in pledging. The stock price keeps varying and as a result of this variation, the pledged share as a security also gets fluctuating.
- Companies Basics: According to Warren Buffet, if a company has a firm foundation then they don’t need to be concerned about the external barriers. On other hand, pledging of shares with secure cash arrangement is not a caution. A company with weak performance history, faulty principles etc is a sign of financial warning.
How can one Pledge Shares?
If you are planning to pledge shares, then follow the below given steps;
- The promoters can use the trading terminal to make a request for pledging of shares.
- The trading terminals forward the received request to NSDL/CDSL for confirmation.
- The request authentication by the NSDL/CDSL using mobile/email confirmation for PAN/BOID.
- Once the request is approved, promoters are made available with collateral margins for trading.
So, if you are investigating a stock through the company’s fundamentals, then there are various factors to be considered. Aside from scrutinizing the management quality and financial ratios, focusing the promoters pledge share is critical in knowing the sign of a company’s financial overcomes. Always keep in mind that, if you come up with a company with more than 15-20% of pledge share by the promoters, be aware of its cash flow prior to any plan for investment. A company with a large number of promoters share holds, the possibility of stock price erosion prominent. Check for trends in pledging of shares, companies with great cash flow and less debt-to-equity ratio. Meanwhile, increased diversification would be a warning.