Point blank. Needless to fret over Adani stocks in Nifty indices

The Adani-Hindenburg saga has rocked the stock market over the past month with stocks belonging to the group losing over 60 per cent of their value.

There is no doubt that prices of these stocks had raced far beyond their intrinsic worth and a correction was overdue, especially given the group’s precarious finances.

But such swings are par for the course in stock markets and the reaction this episode elicited from market participants and other experts appears somewhat over the top.

Especially given that the Hindenburg report only sensationalised facts already in the public domain, using hyperboles such as the ‘greatest con in corporate history’ to catch public imagination. But a fraud has not yet been established by any regulator.

As Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, noted, “The Adani Group collectively carries about three times as much debt as it should, confirming that the group is over-levered, but note that this is a bad business practice, not a con.”

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But the issue has gained political overtones and a battle royale is raging on social media platforms between supporters of the ruling and opposition parties.

The trouble is, not many of these social media ‘experts’ are fully conversant with stock markets, resulting in some weird suggestions and advice being meted out to the regulators and exchanges.

One such ludicrous suggestion has been to remove the Adani stocks from prominent stock market indices.

“Adani Enterprises and Adani Ports; after what they are going through for the last one week, are they still eligible to be part of Nifty 50?” quizzed a tweet. The twitterati have also been questioning the recent index shuffle announced by NSE in which five Adani stocks were included in various Nifty indices. But far from being a diabolic plot to support the Adani stock prices, the NSE index changes is a regular semi-annual affair, based on automated processes.

It needs to be understood that there are time-tested methods to periodically review and change index constituents both in India and overseas. These rules need to be followed meticulously to provide certainty to investors and funds tracking the indices. Ad hoc changes to index constituents every time a stock belonging to the index falls sharply, would make life very difficult for investors as they would have to change their portfolios accordingly.

Besides this, stock markets have in-built checks and balances which ensure that the stocks which fall out of favour, exit from the indices.

Asking for removal of Adani stocks from domestic indices therefore has little merit.

Why the inclusion in indices?

The reason why Adani stocks such as Adani Enterprises and Adani Ports and SEZ are part of the Nifty indices is because stock selection for indices is primarily based on the market capitalisation (number of issued shares multiplied by stock price), liquidity and extent of trading in the counters.

For instance, to be a part of the Nifty 50, the stock should be among the 100 largest companies based on market capitalisation, have a large proportion of non-promoter holdings, should be widely traded and should have derivative instrument attached to it.

Similarly, stocks in the Nifty 500 index represent the largest 500 listed companies based on full market capitalisation.

In other words, stocks in the benchmark indices are the most popular or the most traded and not necessarily those with best corporate governance or the most ethical.

The argument that index funds are being forced to buy Adani stocks because they are part of important indices and hence they should be removed, is also debatable. It is an accepted fact that passive funds are exposed to the risk of owning bad pennies which sometimes get included in indices.

Coming to the furore over recent NSE announcement that five Adani stocks will be added to Nifty indices from March 1, this is just a periodic rebalancing done by NSE every six months ending January and July using trading data of the past six months.

The meteoric rise in the stock prices of Adani Enterprises, Adani Total Gas, Adani Ports etc in the six months to January 2023 has resulted in these stocks finding a place in many of the Nifty indices in the latest reshuffle.

Checks and balances

But the subsequent decline in these stock prices will ensure the exit of these companies, if prices continue to slide or remain under pressure. Stocks of other companies where financial or accounting fraud has been proven have been pummelled by investors and have gradually faded into the horizon.

For instance, Vijay Mallya’s Kingfisher Airlines’ stock was trading above ₹300 in 2008, in its heydays. But as reports of the promoter defaulting on bank loans of over ₹9,000 crore and being involved in money laundering became known, investors flew out of the stock and it is currently trading at ₹1.30.

Similar treatment was meted to Satyam Computers when the promoter owned to committing a gigantic accounting fraud.

Stocks where financial irregularities or stock manipulations are proven are sure to be dumped by all investors. This results in their exiting stock indices too, as their market capitalisation shrinks.

Six Adani stocks — Adani Enterprises, Adani Total Gas, Adani Green, Adani Transmission, Adani Ports and Adani Power — ranked among the top 50 stocks in terms of full market capitalisation towards the end of December 2022. Adani Enterprises was the 10th largest at that time.

But following the intense selling faced by these stocks after the Hindenburg report, Adani Enterprises has slipped to the 32nd position by February 24 and only two Adani stocks — Adani Enterprises and Adani Ports — featured among the top 50 measured in full market capitalisation.

It is quite certain that many of the Adani stocks will have to exit Nifty 50 and Nifty next 50 index in the August review, if the stocks continue in the bear’s grip.

It would be best not to make unreasonable demands for index reconstitution in the meantime. The existing index maintenance processes have worked well over the years and there is no need to tamper with these.