(This appeared in the recent issue of Moneylife)

In the recent fall in prices of small and mid cap stocks, we all have a big lesson to learn. A friend of mine sent me a list that had the names, prices etc of around 350 stocks that had touched their 52 week lows. I glanced through the list to see if there is anything interesting in them.
My first reaction was that this list had a major proportion of stocks that were ‘operated’. What are the typical characteristics? For one, they have limited retail interest. Less than fifty thousand shareholders are typical of most Indian companies. And average retail holding tends to be a hundred to five hundred shares. There is no reason for the stock to churn up large volumes on the bourses, unless there is a clear manipulative activity which gives an illusion of liquidity and also is part of a larger exercise by the promoters to rig the price. Why do the promoters rig prices? One reason is to keep trading and making money on the ‘unofficial’ promoter holdings. The other reason is to create an illusion of liquidity as well as pushing the prices higher, with a view to enable a ‘Qualified Institutional Placement’ with Institutional investors.
For most Indian companies with low market cap (say less than Rs.500 crore) there is hardly any institutional demand. And surely, the retail shareholders hardly trade their holding every day. Most retail investors tend to either hold on for long or sell on listing.
To create an illusion, the promoter approaches a few ‘operators’. Many times, some broking houses approach companies saying that they will ensure ‘interest’ in the company stock by writing research reports, road shows etc. Once all arrangements are in place, there are a few entities which will keep buying and selling the shares on a daily basis. Most of them will have a ‘Loan Against Shares’ facility from a NBFC. There can be up to twenty or more corporate entities involved in this activity. Essentially, circular trading happens in a way that it creates an impression of volumes as well as help to move the price up. A few stray retail investors participate. In a vicious market, they are like the victims of stray bullets!
The one classic symptom which most of these stocks displayed was their getting locked on the lower circuit for several days in a row. This can happen when the operator ceases his activity. The recent cessation was perhaps due to some of them getting scared of regulatory action or the NBFC’s pulling the plug. Regulators can easily catch these operators if they want to. The trail is open enough. The other sign is the percentage of ‘deliveries’ to the total traded volume. In these kinds of counters, it is rare that anyone other than an operator would indulge in ‘intra day’ activity. The first smell of suspicion is the breakdown of the volumes traded. The lower the delivery volumes in these small stocks, the greater are the probability of manipulative trading.
The other is to look at the pattern of ‘block’ trades. Most times, you will see names of a few investment companies repeating. If you track the data on a yearly basis, some names seem to be present in a group of stocks. Whilst it may not be conclusive evidence, it surely smells.
Look at the number of shareholders. Look at the institutional investors’ breadth. Domestic institutional investor presence is easily ‘bought’ by many promoters through brokers who ‘fix’ the fund managers. If you look at the list of investments of most domestic institutions, it would have such obscure companies, that you cannot but doubt the integrity of the institution.
So, what did the list tell me? Yes. If one wants to be focused on integrity and transparency, the universe of listed stock shrinks by as much as ninety to ninety five percent. The second thing is one has to keep track of operators if you want to get in to the second rung companies. In the small companies, the main issue is also that without an ‘operator’ it would be almost impossible to buy and sell shares.
I have gradually seen promoters using the operator route to make money on the side and when they are able to ramp up the prices to very high levels, even by their own yardsticks, they sell part of their holdings. Then over time, they bring the prices down and then use the QIP route to allot themselves warrants to shore up the holding.
So, if I have to take a chance, I will perhaps make a list of five or ten of these companies and place a few bets. These bets would hinge on whether and how soon the concerned promoters get back to action. Of course, you can exercise some extra checks by looking at numbers (often pointless because when the promoter can rig share prices, he can rig anything) and taking a view on whether the stock is such that sooner or later one can find an institutional buyer.
This is the cycle that most Indian stocks go through. Understand it and gain from it.

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