GMM Pfaudler Ltd was having its moment in the sun until Monday. Its shares had risen by about 240% in the past one year to 5,203 on the NSE. The sudden announcement of a large stake sale by existing shareholders has left a sour taste with stock market investors. The floor price for the offer for sale (OFS) issue was set at 3,500 apiece, far lower than the prevailing market price.

The upshot: GMM shares have corrected by 10% in each of the past two trading days, and there are no buyers yet after the nearly 20% correction.

“Usually an OFS is priced at a small discount to the existing share price. But GMM’s 33% discount is the steepest so far,” says Deepak Jasani, head of retail research, HDFC Securities.

But this needs to be seen in the backdrop of the sharp run up in the stock, Jasani adds.

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Runaway rally

Based on Monday’s price, the GMM Pfaudler stock was trading at a multiple of 105 times trailing 12 months earnings. In fact, the stock’s hardly cheap even at the floor price of 3,500, trading at a 70 times trailing earnings.

But GMM’s high valuations and the 33% discount in the OFS issue are not the only things that stand out in this story.

Securities lending and borrowing (SLB) data shows large borrowings occurred in the stock over the past one week. With the OFS announcement following soon after, and the steep ongoing correction in the stock, it raises suspicions. Needless to say, it is a matter for the Securities and Exchange Board of India (Sebi) to look into.

The biggest lesson for investors is that there are significant risks to just riding the latest wave or fancy in the markets.

It seemed like there is no stopping for GMM Pfaudler shares, especially after being backed by some popular fund managers. But who would have imagined that a large stake sale by an existing shareholder would bring a reality check to the valuations?

In all, a total of about 20.5% stake is being sold, which is striking, considering GMM’s free float earlier stood at 25%.

Typically, when demand for a low free float stock is high, then valuations keep moving further upwards owing to the short supply of the shares.

It’s worth noting now that as the supply of GMM shares increases substantially in the market post the OFS, there could well be further downward pressure on prices.

An analyst requesting anonymity said, “GMM is a very well-run company. The stock started getting noticed and everyone starting talking about it. It was all shown as educating people. In this process, people started raising bids and valuations kept skyrocketing.”

Many have lamented about the OFS discount. But this development is also a not so gentle reminder to investors to pay heed to valuations as well.

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