Should you panic if promoters sell their shares?

Thu, 11 Sep Pre-Open

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As a general thumb rule, the promoter's stake in the company reflects his confidence and commitment towards the business. A promoter increasing his stake is seen as a positive sign. And conversely, when the promoter decreases his stake in the company, shareholders tend to become nervous and sometimes outright panicky.

Like the way it happened recently in the case of Jaiprakash Associates, the flagship company of the Jaypee Group. The stock has been severely battered over the last one week. What was the trigger?

On the evening of 3rd September 2014, promoter group firm Jaypee Infra Ventures reported in a filing with the BSE that from 1st September to 3rd September it had sold off about 35.3 million shares of Jaiprakash Associates through open market sale.

This caused minority investors to panic and the stock witnessed massive selling pressure on 4th September tumbling close to 18% during the trading session.

The company was quick to come up with a clarification stating that rumors had been planted in the market suggesting that the promoters were selling off their shareholding. It pointed out that stake sale by Jaypee Infra Ventures represented just 1.45% of the company's total equity capital. And that the promoter group entity continued to hold 28.3% stake in the company. It tried to further explain that the small share holding had been sold off by the promoter company to meet its requirement of funds including for social cause.

But minority shareholders didn't seem convinced. The company's clarification couldn't salvage the stock from the massive sell off even the next day's trading session. Over the two trading sessions alone, the stock price of Jaiprakash Associates crashed by over 26% to around Rs 34. It's been a week now and the stock continues to languish around similar levels.

What could be the reasons for the investors' pessimism towards the stock?

While the immediate reasons could the promoters stake sale and possibility of a cash crunch. But there is more to it than just these recent developments.

For one, the stock has been an absolute non-performer. Had you invested in the stock in early September 2005, your returns on the stock would have been either zero or negative. In fact, the stock is down close to 90% from its 2008 peak levels.

The company has an overstretched balance sheet. Earnings have gone nowhere. A small percentage of the promoter group shares are pledged.

It is worth noting that the company was once part of the BSE-Sensex and the NSE-Nifty indices. But it was dropped from the BSE-Sensex in January 2012 and from the NSE-Nifty index in March 2014. So you see, simply being a large company doesn't make one a safe blue-chip stock.

It is clear that investor confidence in the company is very low and hence the management's clarification has done nothing to assuage investor concerns. Another lesson here is to keep in mind that positive market sentiments and plush liquidity alone will not drive all stocks higher.

All in all, promoter stake sales are generally not taken too well by investors. But it is not always a bad sign. It important to see the stake sale in the context of the overall business and shareholder wealth creation. You have to be prudent and diligent in separating the wheat from the chaff and invest only in fundamentally sound businesses run by a committed management.