Investing is an art that never stops evolving, and as investors, we’re always in search of new techniques that maximize returns. One such strategy that came to my attention is tied up with preferential allotments, a fund-raising technique companies implement. Here’s how one can do it.
What is Preferential Allotment?
Preferential allotment is a source where the company raises funds by issuing new shares to a certain group of investors. These investors can be:
existing shareholders
promoters of the company
strategic partners
selected outside parties
Therefore, what makes preferential allotments interesting is that the majority of them are issued below their market value. This provides an added incentive to the participating investors.
Why Companies Prefer Preferential Allotments?
Companies prefer preferential allotments because fund raising through more traditional routes like IPOs or public bond offerings is time-consuming and expensive. Instead, by targeting a smaller group of investors, companies can:
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- Raise funds with more speed: The process is comparatively quicker and involves fewer regulatory hurdles compared to public issues.
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- Save costs: By cutting down on underwriting fees and other expenses associated with public fundraising.
Mostly, companies employ the funds they raise from preferential allotments for the following purposes:
1. Expansion/ Growth Capital Vodafone Idea raised ₹2,000 crores through preferential allotments to improve their 4G network and fund the deployment of 5G. They needed to do this for their ability to match large telecom companies in the industry.
Some firms have used the money to clear pending dues. For instance, Vodafone Idea had issued shares of ₹2,458 crores to Nokia and Ericsson to pay off debt and had given them small stakes in the process.
3. Capital Building End
At other times, the money raised helps comply with the regulator or improve the financial health of the company. IDFC First Bank recently issued ₹3,200 crores in a preferential allotment to raise its capital adequacy level.
What Preferential Allotments Mean for the Retail Investor
Preferential allotments are overwhelmingly favorable to the selected investors; however, they do provide some benefits for retail investors as well:
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- Positive Signal: Preferential allotments are undertaken by companies with regards to financing growth opportunities or strategic alliances, thus signaling the strength of future performance
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- Transparency: Unlike open-market purchases by promoters, preferential allotments are publicly announced, thus retail investors understand the intentions of the company.
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- Regulatory Protections: SEBI provides regulations pertaining to fair price consideration and misuse of preferential allotments. The same includes directions regarding lock-in periods, approvals from shareholders, and pricing methodology.
My Investment Strategy Based on Preferential Allotments
The strategy, quite simply, was to follow the money. If reputed investors or company promoters are coming in on preferential allotments, then obviously they believe in the company. I followed the same approach and identified such opportunities to invest with them.
How It Was Implemented
1. Data Collection
I collected data on companies that were raising shares by way of preferential allotments, keeping track of:
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- The date of issuance
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- The issue price
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- The current market value of the stock
The sources used for the above information are:
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- News portals such as Moneycontrol and Economic Times
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- Websites of the stock exchanges (BSE and NSE)
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- Aggregators like Screener.in
2. Key Patterns Identification
I analyzed whether the stock prices of these companies rose after the preferential allotment. My findings were remarkable:
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- Four out of 17 companies more than doubled in value within months.
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- One company, TCC Concept Ltd, achieved an astounding 700% growth in just seven months.
3. Portfolio Performance
If I had invested in all 17 companies on the day of their preferential allotment, my portfolio would have fetched 137%. Even without including the phenomenal 700% return from TCC Concept Ltd, the balance portfolio was delivering an annualized return of 61.8%, thus leaving other broader market indices like Nifty 500 well behind.
Why This Strategy Works
This strategy works best because it aligns with market psychology and fundamentals:
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- Strong Backers: When big investors or promoters participate, it builds market confidence in that stock.
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- Growth Focus: They usually use the funds raised for expansion or debt reduction, which works well for their long-term prospects.
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- Regulated Pricing: The SEBI rules prevent under-value allotments of the stock, thereby giving little or no chance for undervaluation.
Limitations and Considerations
This strategy seems pretty attractive; however, it does have a few risks attached:
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- Stock Specific Risks: All the companies do not issue their stock through preferential allotments. One must observe and analyze the company’s reasons and financial conditions before investment.
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- Market Conditions: Broader market trends can impact stock performance regardless of preferential allotments.
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- Timing: The stock price may not react immediately, requiring patience from investors.
How You Can Start
If you’re interested in exploring this strategy, here’s how you can begin:
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- Set Up Alerts: Use platforms like Google Alerts for terms like “preferential allotment” or “preferential issue.”
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- Tracking Corporate Announcements: Real-time updates available under the Corporate Filings section on stock exchange websites.
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- Research Tools: You can use platforms such as Screener.in or even specialized apps like Sovereign to find companies issuing shares through preferential allotments.
End
Preferential allotments are an excellent method not only for the companies raising funds but also for investors to identify high-potential stocks.
But any investment approach requires proper research and due diligence. Be it a seasoned investor or a fresher, incorporating preferential allotment insights into your strategy may be the next big move for you. **Happy investing!