The crash of Adani share prices is not just about retail investors

Expressing concern over this, Chief Justice of India D.Y. Chandrachud said on 10 February: “How do we ensure protection of Indian investors?... How do we ensure that what happened does not happen again in the future?" He was addressing Solicitor General Tushar Mehta, who was appearing in the Supreme Court on behalf of our stock-market regulator, the Securities and Exchange Board of India (Sebi).

To answer these questions, we need to understand how a stock market operates. For a stock market to function, every buyer needs a seller and vice versa. As Daniel Kahneman writes in Thinking, Fast and Slow: “Most of the buyers and sellers know that they have the same information; they exchange the stocks primarily because they have different opinions. The buyers think the price is too low and likely to rise, while the sellers think the price is high and likely to drop."

Let’s try and understand this in the context of Adani Enterprises. The stock price started running up from April to June 2020 onwards. As of March 2020, the promoter holding was 74.9%. A bulk of the remaining stock was held by foreign institutional investors (FIIs). There were 76,569 individual investors who owned shares with a nominal value of up to ₹2 lakh. They owned 1.9% of the firm. Let’s call these investors retail investors.

As of March 2021, the number of retail investors had increased to 143,639 and they owned 2.4% of the firm. The promoter holding continued to be at 74.9%. Life Insurance Corporation (LIC) of India had largely no investment in the firm at this point and started investing during the period April to June 2021. By March 2022, it owned 3.7%. Further, by March 2022, the number of retail investors had jumped to 216,793, though their ownership had dropped to 1.9%. The promoter stake continued to be the same.

So, over the years, the bulk of Adani Enterprises has been owned by the promoter group and FIIs. In this scenario, there was very little free float going around. The ownership was concentrated.

As of 1 April 2020, the closing price of the stock was around ₹134. By 1 April 2021, it had jumped to ₹1,106 as retail ownership increased. It jumped further to ₹2,043 by 1 April 2022 and reached an all-time high of around ₹4,165 on 20 December 2022 as LIC’s ownership of the stock increased.

How did this happen? Now, every buyer needs a seller. Second, the free float of the stock was very limited. Hence, as newer investors, retail or LIC for that matter, started buying, they needed to offer a higher price to get enough sellers interested and be able to buy, driving up the price fast.

Now, the retail investors who bought the stock may or may not have known about the low free float. Let’s assume they knew and still went ahead and bought. They were, as John Maynard Keynes once said, devoting their intelligence to “anticipating what average opinion expects the average opinion to be". And their guess was that the price will go up fast. They were being greedy. The same stands true for those who didn’t know about the low free float.

One set of investors knew the risk and were looking to unload their investment on to ‘greater fools’. Another set didn’t know the risk they were taking on. Now there is nothing that the regulator can really do about this. Individuals who do not understand the risk of what they are taking on have the option of investing in equity mutual funds (MFs). If they don’t do so, it is perhaps because equity MFs aren’t exciting and don’t provide the kind of mental stimulus that the price of a single stock going up fast does.

Also, any market needs its set of speculators. A market with only long-term investors will have no liquidity—when a seller wants to sell, there will be no buyers and vice versa.

In this scenario, there is nothing much that Sebi can do about individual greed, which keeps the market going. Hopefully, investors would have understood by now that if the low free float of a stock can lead to prices going up quickly, the fall can also be very fast.

Honestly, what needs to be discussed more is the investment behaviour of LIC. Data from stock exchanges tells us that LIC owned 2.6% of Adani Enterprises as of March 2017. The stock price on 31 March 2017 stood at ₹58. In the period between April and June 2017, LIC sold this stake in Adani Enterprises. It started reinvesting only four years later during April to June 2021. By then, the price and thus valuation of Adani Enterprises was at extremely high levels. Also, every time LIC bought these shares, it must have pushed up share prices higher, simply because of the low free float.

Finally, what India’s market regulator needs to investigate are the allegations made by Hindenburg Research in its report—to check if they are true. That’s the real deal. The truth, either way, needs to come out.

Vivek Kaul is the author of ‘Bad Money’.