Stock Split and Buyback of Shares What you need to know

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    29. Bonus Issue of Shares Explained and How They Work
    30. Stock Split and Buyback of Shares What you need to know
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Marketopedia / Stock Markets Basic / Stock Split and Buyback of Shares What you need to know

Stock split 

The term “stock split” may sound peculiar, however, it is a frequent occurrence on the markets. That is to say, the stocks that you own are actually split!

A bonus issue and a stock split both results in the owners gaining extra shares. The main difference between them is that with a bonus issue, the face value of the company stays the same, but with a stock split, it changes. For instance, if you had one share worth Rs.10 before a 1:2 split happened, then after it has taken place, your assets comprise two shares valued at Rs.5 each.

To demonstrate this, let’s use an example.

Split Ratio Old FV No. of shares you own before split Share Price before split Investment Value before split New FV No. of shares you own after the split Share Price after the split Investment value after the split
1:2 10  100  900  90,000  5 200 450  90,000
1:5 10  100  900  90,000  2 500 180  90,000

A stock split has the same key dates and timeline as a dividend or bonus issue, but it is designed to encourage increased retail investment by lowering the price of each share.

A rights issue is a process in which companies issue securities to their existing shareholders, typically at a discount from the prevailing market price. The process helps them to raise capital, and it offers existing investors the opportunity to buy more of the company’s shares.

A rights issue is a way to increase a company’s funds without going public. Instead, the corporation approaches existing shareholders. In effect, this is like another Initial Public Offering (IPO) for select people instead of the whole public. A possible motivation behind such an issue might be to reflect positive new developments within the firm, although, this isn’t always the case. 

Consequently, as an investor, it’s important to assess why they’re having a rights issue and if it is merited or not. The subscription rate of these new shares will be based on the percentage of existing assets held by each shareholder; for example – the 1:4 rights issue means one more stock can be acquired for every four already owned. 

Pricing-wise, this could involve a promotional discount from what’s offered in the market; i.e., if a particular share is trading at Rs.500 each, the corresponding right issues may be available at Rs.400 per share with a 20% deduction applied.

Please note, you have to be cautious when considering an investment in a company’s rights issue; although the discount can be attractive, one must look beyond it. 

Consideration should only be given if the investor has full faith in the firm’s future prospects. In fact, the stock may fall below the offer price after it is announced, meaning purchasing from the open market would be a less costly option.

Buyback of shares

A buyback is a way for a company to invest in itself by purchasing shares from other investors. This process decreases the amount of outstanding stock, making it an important corporate restructuring strategy. Corporations may opt to buy back shares for various reasons…

  1. Enhance the effect of each share on profitability
  2. To consolidate their stake in the company.
  3. To avoid being taken over by other companies.
  4. To show the confidence of the promoters about their company.
  5. To prevent the share price from dropping in the markets.

When a company announces a buyback, it indicates its confidence in itself. This can often increase the share price, though it is always advisable to consider the underlying reasons for the buyback before making a decision.