Why investors must keep an eye on rising promoter stake sales

On February 21, Sasikala Raghupathy, the promoter and non-executive chairman of Chennai-based capital-goods firm BGR Energy Systems, started paring her stake in the company. A day prior, shares of the company closed at ₹113 apiece, almost close to their five-year high of ₹118. The market capitalisation stood at around ₹820 crore.Over the course of the next nine days, Raghupathy sold her entire 24% stake while the stock price plummeted to close at ₹49.43. The market cap fell by more than 50%.For a stock trading on thin volumes, the absorption of such a large quantity of shares could have led to a price correction. Or perhaps, the market was seeing the news of a promoter selling stake in conjunction with the resignation of the company’s chief financial officer and company secretary on February 14.Whatever be the case, more bad news followed soon.On March 19, BGR Energy informed the exchanges that State Bank of India’s stressed asset management branch in Chennai had appointed Chaturvedi & Company to conduct a forensic audit for the company. In April, BGR Energy informed the exchanges that its operational creditor, RDC Concrete India, had dragged it to the National Company Law Tribunal for corporate insolvency resolution process.The only good news was that the company reported a net profit for the March quarter after nine straight quarters of loss. However, this turned out to be a blip as it returned to making losses in the first quarter of FY25. On September 13, shares of BGR Energy closed at ₹45.65 apiece.In a bull market, euphoric investors with a voracious risk appetite are eager to invest in growing businesses. Equity gets richly valued as they crowd the market looking for the next multibagger stock. Sometimes, promoters sell stake at these rich valuations to raise funds for expansion or to deleverage the balance sheet. At other times, a promoter may need to cash out to meet some financial obligations. After all, equity held in a company is also an investment made by the entrepreneur.So, promoters reducing stake in the business may not always be a bad signal for investors. However, there are a few who often take advantage of the euphoria. They sell their equity at rich valuations and leave investors holding stocks of a failing business. The question is: How do investors separate the wheat from the chaff in a crowded market?“Whenever investors become overly optimistic and are willing to buy based on hope, manipulators and fraudsters get active. It happens in every bull market,” says Amit Mantri, co-founder of 2Point2 Capital.Mantri’s firm uncovered discrepancies in the books of Manpasand Beverages, which eventually culminated in regulatory action against the company and delisting of its shares from public markets.“It wouldn’t be surprising to find many companies in the current bull market manipulating books, driving up the stock price by reporting fake profits, getting rich valuations, and then promoters selling stock and monetising their ill-gotten gains,” he adds. medium113385047Alarm bells or snooze?Promoters have already sold stakes worth ₹88,845 crore in the first eight months of 2024, which is more than 2.5x the amount raised in 2022, according to Prime Database, a market intelligence site. In 2023, promoters sold stakes worth ₹1.17 lakh crore, up 3.7x from 2022.“This activity (promoter stake sale) has gone up substantially in the last year or so. The collective amount of money which has been quickly mobilised by promoters and largely at rich valuations in worrisome,” says Sharad Pachisiya, CEO of equity PMS & AIF platform, SageOne Investment Managers.But he warns investors against treating every stake sale by a promoter as a red flag. In fact, he shares that his firm has acquired stake from selling promoters in a few companies recently and so far, some of these investments have already given handsome returns.Take the case of Inox Wind, where promoters sold ₹900 crore worth of their stake in the secondary market and infused it back into the business to cut down the company’s external term debt. Since the stake sale on May 28, at ₹151 apiece, shares of Inox Wind have risen nearly 66% as of September 13.Promoters can sometimes also sell shares in the company when they see an asset arbitrage opportunity. In the case of Whirlpool of India, the US multinational parent sold 24% of its stake in the Indian business because the latter was trading at a price to earnings (PE) of more than six times higher than the parent company. These funds were used to cut debt of the US-based parent company. To abate investors’ fears, the CEO of Whirlpool Corporation also reconfirmed the parent’s commitment to the India business for the long run.Even after the promoter sold shares of Whirlpool of India at ₹1,230 per share, the stock continued its rally and is currently trading at ₹2,101.But not every promoter share sale has a happy ending. ET Prime has compiled a list of 15 stocks where shares of the company are trading at a lower price than the exit price of the promoter. medium113385083Stake saleMany of these are small- and mid-cap companies from the infrastructure and capital-goods sectors. Incidentally, many fund managers and market gurus have warned investors that the valuations of companies in these sectors and within defence and railways are unsustainable.“Investing by taking just a top-down view on favoured themes like capital goods, railways or defence can prove costly for investors considering the steep valuations these sector stocks are trading at. Merely getting orders doesn’t translate to healthy profitability for a company,” Pachisiya says.Investors should be more observant about promoter share sale in the capital-goods and infrastructure sectors as these are cyclical businesses that are capital-intensive. Promoters often need to use both debt and equity to satiate the capital needs of these businesses.Project delays, liquidity issues and execution challenges are common risks in these businesses. Many companies in these sectors have eroded investor wealth during the last capex cycle and some even during the 2017-18 small- and mid-cap rally.In 2018, the small- and mid-cap rally came to an end when a series of auditor resignations occurred in April-May. While key personal resignation is a good cue for investors, Mantri says they must also question promoter stake sale that follows soon after the company shares an overly optimistic business guidance.“In the last few quarters, we are seeing an increasing trend of companies giving aggressive guidance on their business performance and then doing a QIP or selling stock,” says Mantri, adding that when the promoter sells stake after giving an aggressive guidance seems like a pump and dump.The final cutBesides infrastructure and capital-goods companies, the list surprisingly includes two IT stocks — Cyient DLM and Happiest Minds.In April, the Cyient DLM management gave a guidance of revenue growth at 30% CAGR (compound annual growth rate) in the next three years and improvement in RoCE (return on capital employed) from 15% to 25%. A month later, Ashok Soota-promoted Happiest Minds gave a guidance of 35-40% revenue growth in FY25 with an operating margin of 20-22%.So far in the first quarter, the margins haven’t improved for either of the two companies and neither has the profitability met expectations. In the case of Cyient DLM though, towards August-end, an array of institutional investors like Morgan Stanley, Citigroup, Aditya Birla MF, Edelweiss MF and Nippon India acquired stakes from the promoter at ₹764 apiece. The shares of the company closed at ₹703 on September 13.On June 25, Soota sold 6% of his stake in Happiest Minds and the stock closed at ₹830, touching an intraday high of ₹852. As on September 13, the shares of the company closed at ₹820.Promoters selling stake is a feature and not a bug of every bull market. And as the rewards get higher, so do the risks. Thus, euphoric investors betting on the next multibagger in this giddy bull market must tread with caution. Else, they could end up owning the next Kingfisher Airlines while forsaking the chance to invest in IndiGo.