There are various ways of making money in the stock markets. And there are numerous ways of losing money too. The world in which we live today is changing at a rapid pace, mainly thanks to technology. Taking a long term view of your investments becomes challenging when the underlying dynamics change fast. This practical difficulty in investing has only grown with time. Does that mean the times of Warren & Charlie are gone? Not really, let's discuss that point a little later.
When a promoter is running the show behind a business, he is there to make money. For some promoters, making money is the primary objective, whereas for others, creating value for stakeholders is the primary objective. This latter breed of promoters believes that money will be made in the process of running a business ethically. Indians are fortunate to have some entrepreneurs who have consistently put the value creation objective at the forefront. Needless to mention, one such business house is the Tatas.
What about those promoters whose primary objective is making money? Is that a wrong objective to have? Not at all, we are all here to make money! So what are the options that this breed of promoters have: Run the business efficiently, increase the topline, reduce operational expenditure, increase the asset turnover, optimize the working capital, manage human resources well, arrange for capital at a reasonable cost, liaison well with the Govt, and most importantly hope for luck to be in your favor. Wait, doesn't that seem too much to do? Is there no quicker alternative to making money by starting your own business and taking the company public? Well, certainly there is a way out, and indeed a much easier way: trade the stocks of your own company.
Let me start the discussion with the Vedanta episode. Recently, the group has announced that they intend to delist the company from the exchanges. The delisting story is not new to Indian promoters. The business is quite simple: 1. Come up with the IPO, 2. Make sure people like the story, 3. Sell them the stock, 4. Wait for the stock price to collapse (or in some cases, make it collapse), 4. Create a distress situation for minority investors, 5. Give them an offer of buying back their shares at a ridiculously low price.
Here's the chart for your reference. I am sure you will be able to relate with steps 1-5 from the following chart:
Like I mentioned before the delisting game is not new to Indian companies. In the year 2002, Sterlite Industries delisted from the exchanges by making use of section 391 of the Companies Act, 1956. Section 391 allowed Sterlite to bypass section 77 of the companies act. Section 77 deals with buyback of shares and in a way was meant to protect minority shareholders. A few weeks later, shockingly, Godrej industries came up with a scheme similar to Sterlite. Investors were shocked with a group like Godrej trying to benefit at the expense of minority investors. Godrej Industries decided to come up with a buyback offer at a price of Rs. 18 per share. At that time, the book value per share for the company was Rs. 45. That's a steep discount! A couple of days before the buyback announcement, the shares of GIL were trading at Rs. 24 per piece.
What did the market regulator SEBI do to protect minority shareholders? Well, it did appeal to the Bombay High Court. To its dismay, the high court ruling was in favor of Sterlite Industries and Godrej Industries. SEBI took the matter to the Apex court, however, the Apex court too ruled in favor of the concerned corporates. Finally, these buybacks went through and minority shareholders were at the receiving end.
While what these companies did was completely legal, the question is what was the intent behind taking these steps? Selling shares at a high price and buying it back at much much lower prices, is the instinct of a trader, isn't it?
Let me come to something more recent. February 2018 shall always be remembered for all the bad news. In the budget that year, the Finance Minister announced the introduction of LTCG on equity gains. The market reacted adversely in the following days. To grab the opportunity, the Punjab National Bank scam was broken out. The Government too played smartly by clubbing the big brewing scam with an already existing piece of bad news. That same month, news broke out in which Vakrangee purchased some stock in PC Jewellers. Here's the shareholding chart of PCJ:
Data: Tijori Finance
It is quite clear from the shareholding chart that the promoters wanted to reduce their stake since Jul 2017. Obviously the fall in promoter stake was accompanied by a rise in stake by retail shareholders. Here's the price chart of PCJ for you to relate better with the above timeline:
As can be seen, the stock peaked above 500 somewhere in the year 2017. That's precisely when the promoters started getting out. Again, what is this instinct of selling shares at a higher price and buying at a lower price? Yes, it's equity trading!
Let's see a few more examples.
That's the shareholding chart of Yes Bank for you. As can be clearly seen, there was a trend of falling promoter stake for many years before the NPA divergence saga came out in open.
Here's a shareholding chart of Sterling Biotech. In this case, the promoter stake was not falling significantly, but the real issue was the pledged shares.
Now, let me take you to the biggest Indian company by market cap, Reliance Industries. Here's a screenshot of Reliance Industries shareholding chart. Ambanis have been upbeat on Jio and Retail and that confidence is well reflected in their increasing shareholding.
Here is a summary of points to be learned:
The law doesn't forbid promoters to trade in their own shares. However, there are some restrictions, which are sometimes possible to evade by way of exploiting loopholes in the law.
Corporate actions and shareholding pattern change can give a heads-up on the promoter's intent towards minority shareholders.
Promoters, foreign institutional investors, domestic institutional investors, and retail traders are the various types of investors. In the short term, all of them cannot win at the same time. At the end of the day, stock market trading is a zero-sum game in the short term. Real value creation and compounding happen only over a long period of time. Retail traders are almost always on the losing end in the short term.
When you invest in markets, there are various risks. Business risk, geo-political risks, risks from natural disasters, and promoter risk. Promoter risk is not spoken very frequently, however, in my humble opinion, promoter risk is the most significant of all. It may not be always realistic to expect the promoters to think in the interest of minority shareholders. Investors should factor-in promoter risk. Not all promoters will always think in the best interest of minority shareholders.
Understanding stock fundamentals is undoubtedly important, but it is in no way sufficient to make money from markets. One needs to be aware of the practical aspects of stock markets.
Promoters are humans, and most humans love quick money. Equity trading is a great source of making quick money if you have the odds in your favor. An easy way of bringing the odds in your favor is by trading the shares of your own company, using information that others are not aware of.
Judging promoter intent is an art and one can try to stay away from dubious promoters by observing corporate actions. Thanks for reading.