Stock promoters are individuals or organizations responsible for raising capital for a client company through various marketing strategies. They are primarily hired during pre-IPO (initial public offering) stages with the task of creating market awareness about a company, thereby encouraging investors to obtain respective equity securities.
Promoters play a significant role in the success of a start-up organization and are usually paid in terms of equity shares of respective holding companies in proportion with the total capital raised. Apart from market strategies implemented to incentivize investment in a particular company, holdings of a stock promoter also influence the total trade volume of its equity shares in both primary and secondary markets.
Types of Promoter
Depending upon the nature of an issuing company/authoritative body, stock promoters can be classified into the following categories –
- Penny promoter
One of the most popular types of promoters, such individuals/company is in charge of creating awareness regarding a start-up business among residents. Such promotion can cater to both resident and non-resident individuals, depending upon the requirements and guidelines pre-set by issuing companies.
Penny stocks are often considered as a dubious form of investment, as no adequate knowledge regarding the issuing companies and services provided are available to individuals. In India, all stocks trading below Rs. 10 can be labeled as penny stocks. Such securities are highly speculative as no public information is available, and they often have large bid-ask spreads and consequently, a lower trading volume.
In such circumstances, shares held by a promoter incite confidence among investors regarding the future performance of such start-up companies, thereby promoting the sale of such penny stocks, respectively. Investing in such stocks of companies demonstrating the massive potential for growth and having a strong foundation can lead to significant capital gains through asset appreciation in the long run, as the prices of respective shares can rise manifold.
However, in some instances, a penny stock promoter can also use misleading information about the actual valuation and metrics of a company, causing investors to incur huge losses. To avoid such situations, investors should conduct thorough research regarding the intrinsic valuation and management of a company to gauge its true growth potential in the prevailing market scenario instead of relying completely on stock promoter alerts.
- Promoter specialising in government securities
Debt tools issued by the central government and the RBI are initially traded through auctions and subsequently resold in the secondary market. A promoter often purchases a substantial chunk of such securities and trades it over the counter in major stock exchanges to facilitate investment in government securities by retail individuals not having a Subsidiary General Ledger (SLR) or Current Account (CA) with the RBI.
- Institutional promoter
Gradually, over time, all equity shareholders act as institutional promoters of a company as they advise their friends/relatives over purchasing corresponding stocks. Such a promoter increases a company’s market reputation without imposing any financial strain, and can only be developed based on past performance. High annual turnover and sales, timely declaration of profits and dividend pay-outs, etc. can create an institutional promoter, inducing huge trade purchase volume, which, in turn, drives up the market prices of such shares (through higher demand) in the market.
Stock Promoters and the Stock Market
NSE promoters play a crucial role in strengthening the demand for a particular equity share of a company in the market. High holdings of a stock promoter are usually perceived as a good sign, attracting consumers to invest in a company for making substantial gains.
A high stake of stock promoters implies that such shareholders expect prices to rise in the future due to either the internal performance of the company or expected economic conditions. It leads to a higher demand for such shares among investors in the market who expect to profit from rising prices in the long run.
Stock promoter holdings of a particular company are also analysed during times of bearish market trends when individuals seek to withdraw their investments from equity-oriented tools in fear of capital losses. A high promoter holding during these times reflects that price fluctuations are temporary and don’t have any long-lasting implications on the management and production capability on companies. Such promoter confidence encourages traditional shareholders to keep their investments locked in as well instead of selling them due to short term stock market downturn.
Analysing such promoter holdings during times like stock market downturn is beneficial, as it helps distinguish between bullish market trends and market correction.
Criticism of Stock Promoters
A stock promoter plays a critical role in regulating the demand for shares of a company in stock markets. While a high holding value creates a positive outlook regarding a company’s performance in the future, resale of promoter holdings typically causes panic sale among novice investors. A promoter often indulges in ‘pump and dump’ activity in this respect, to generate high personal earnings from a new business venture.
Pump and dump activities are most popular among penny stock companies, whereby a promoter often procures huge equity stake in such companies. Following suit, many individuals often procure such shares as a positive outlook regarding the company’s future performance is expected. It drives up the prices of such shares rapidly. However, as share prices peak, stock promoters begin to “dump” (resell) their shares in the market. It drives down the prices significantly, as retail investors lose confidence in the investment venture. As such shares have high associated liquidity risks, individuals are subjected to massive losses through resale in the secondary market.
Even though the equity stake owned by a stock promoter acts as a reflector of the company’s potential, several other parameters should be analysed to ensure high returns. Technical analysis indicators such as price to book value, EBIDTA margin, price to earnings ratio, etc. should be considered as well, as they quantify the company’s past performance.