One should be most cautious when the going is good. While this dictum sounds good, it is seldom practised, especially on the Street. Some opportunists actually wait for good times to strike better deals that they don't intend to fulfil when the tide turns.
Share pledging is the act of keeping shares as collateral for securing a loan. A rising stock market motivates many promoters to pledge their shares as they can secure higher amounts from lenders. While share pledging is normal, the problem comes when the stock price of the company whose shares have been pledged declines. In such a situation, the promoter needs increase the collateral, i.e., offer more shares for pledging. This is viewed negatively and can cause the stock price to further tumble.
If the promoter defaults on the loan, his pledged shares could be sold by the lender in the open market. This could even lead to the promoter losing control of the company, creating pressure on the stock price. Hence, investors should avoid companies where the promoters have heavily pledged their shares and the business prospects are also bleak.
In the table, we have listed the companies where promoters' pledging of shares has gone up in the last one year significantly. The stock prices of these companies are either near their 52-week highs or the earnings per share have fallen over the last three years. If the market corrects from here or the earnings pattern continues to be on the downward slope, these companies can feel the heat.