Investors should know what corporate actions are and what effect it would bring about in our investments. This would not only help us to know the share price movement but also to strategize the holdings accordingly. Subsequently, a particular corporate action would help us to infer the ethical conduct of a business and determine whether to buy or sell the particular stock.
What is a Corporate Action?
A corporate action is an event that brings material change to a company and affects its stakeholders, including shareholders, both common and preferred, as well as bondholders. These events are generally approved by the company’s board of directors and the shareholders may be permitted to vote on some events as well.
What are the types of Corporate Actions?
Bonus Shares, Rights Issue, Dividend, Share Buyback, Stock Splits, Mergers & Acquisitions and Spinoffs are the types of Corporate Actions
What is the effect of Corporate Actions on the share prices?
Bonus Shares: These are extra shares gifted by a company to its shareholders. A 1:1 bonus issue implies that the shareholders get one additional share for each share that they already hold. Generally, when a company faces liquidity issues or is not in a position to distribute the dividends, it issues bonus shares out of its reserves or profits. But as a whole, there are no free lunches. In case of a bonus issue, the share price of the company falls in the same proportion as the bonus shares issued. Therefore, in a 1:1 bonus issue, the share price generally will fall by 50%. Other metrics, such as earnings per share (EPS), will also reduce. However, over the long term, and as stock price increases, investors may tend to gain.
We Indians love free things so free shares are not an extraordinary concept and thus there is an increased interest in buying shares of companies after they announce bonus shares, hence it is not advisable investing into a company just for the sake of additional shares. Do check the company’s recent earnings growth trajectory and visibility, capital expenditure (Capex) plans, and schedule of commissioning of Capex plans before purchasing its shares.
Rights Issue: In a rights issue, fresh shares are issued by a company to its existing shareholders. But unlike bonus shares, they come at a price that is usually a discounted price. To illustrate, a 1:5 rights issue implies that you are entitled to buy one additional share for every five shares that you hold. Cash-strapped companies generally turn to a rights issue to raise money. It could either be for debt reduction or to finance the company’s expansion. Do read through the reason for rights issue before you opt for it, also make sure the company has a strong earnings visibility and a credible management system
Impact: The share price will fall in the same proportion as the rights issue.
Stock Split: It refers to a split in the stock into two or more equal portions ( Example 10 rupee Face value share getting split into 2 shares of 5 rs face value each). Stock splits are generally announced by companies to make their shares affordable to small retail investors and thus to make them more liquid. Once liquidity increases, more buyers and sellers trade in the stock, which, in turn, helps to understand its true value.
The stock is split keeping in mind its face value—not the market value. For instance, if the stock face value is Rs 10, and there is a 1:1 split, its face value will reduce to Rs 5. Accordingly, market value also gets adjusted. Stock splits make sense only when the share price of a company is quite high(Best Example is MRF which trades at 68,000 INR).
Impact: The share prices get slashed in accordance with the stock split ratio.
Dividends: a Dividend is a form of income paid to shareholders by a company out of its profits and reserves. Also, when a company does not find any appropriate investment opportunity to deploy its funds, it declares a dividend to share its profits/reserves with the shareholders. A dividend is usually quoted per share or as a percentage of the face value of the share. For example, if a company declares a dividend of Rs 10 per share, whose face value is Rs 10, the dividend is 100%. Investors’ dividend income above Rs 10 lakh is taxed at 10%. Companies are expected to pay a Dividend Distribution Tax (DDT) at 20.93%.
Impact: Share price usually declines in par with the level of dividend paid per share.
Buyback of Shares: a Buyback is an event when the company purchases its shares from shareholders, usually at a premium to the market price. Companies go for buybacks to consolidate their stake in the firm, for greater control, to support the share price from declining, to improve earnings per share (as it will reduce the number of outstanding shares in the market), or/and to build investor confidence in the promoters.
Impact: A buyback may lead to a short-term spike in the share price.
Mergers: Mergers simply means combining two companies into one entity, now if the merged entity will achieve operational and financial efficiency, then the stock will move up. However, if there is a clause or if the stake to be given to one of the companies to the merged entity is low then the share price will fall. ( Best example is what had happened with Idea after the merger announcements)
Impact: Depending on a favorable or unfavorable deal the stock will move up or down respectively.
Acquisitions: This means the company is going to buy another company and integrate it within their own company. Now this acquisition can be done for several reasons – operational or financial synergies, gaining access to market, reducing competition, getting more market share, etc. Now again the same logic of Merger applies here. Best Recent Example is of Indigo
Impact: Depending on a favorable or unfavorable deal the stock will move up or down respectively. In this case, investors in Indigo feared buying a stake in Air India may hurt Indigo’s profitability and hence there was a fall of almost 8% in 2 trading sessions in the Indigo Shire.
Spin-Offs: This means spinning off business into a separate company(separate from the parent company). It is a type of divestiture. Businesses wishing to streamline their operations generally sell less productive or unrelated subsidiary businesses as spin-offs. A company may spin off one of its mature business units that is experiencing little or no growth so it can focus on a product or service with higher growth prospects. The spun-off companies are expected to be more worth as independent entities than as parts of a large business.
In a complete spinoff, the stock price of the company right before the spinoff should be theoretically equal to the sum of its post-spinoff stock price plus the initial stock price of the spun-off company. For example, if a company whose stock trades for ₹50 spins off a subsidiary in its entirety at an initial price of 20₹ per share, its stock price should theoretically fall to exactly 30₹. Of course, because stock prices are continuously changing in a liquid stock market, it’s unlikely to be exactly equal to the original share price minus the spun-off share price, but it should be close.
Impact: Depending upon the condition the stock will move up or down.
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