Corporate actions play a pivotal role in influencing stock prices, whether positively or negatively, regardless of their scale. It’s imperative for investors to grasp the concept of corporate actions and their implications on investments. Understanding these actions not only sheds light on share price movements but also enables investors to devise strategic approaches to managing their holdings effectively. Read to learn more.
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Defining Corporate Actions
A corporate action is an initiative taken by the management of companies or a board in the case of a public limited company that brings an actual change to the financial securities, equity or debt issued by the company.
Corporate actions can be acted in two ways: mandatory and voluntary.
- Mandatory corporate actions are automatically applied where the investments are involved.
- Voluntary actions on the other hand require investor’s actions to be applied.
Acquisitions, company name changes, and stock splits are some of the common examples of mandatory corporate actions. Optional dividends, tender offers, and right issues are examples of voluntary actions.
Some Popular Corporate Actions
Bonus shares, rights issues, dividends, share buybacks, and stock splits are common but severely impact corporate actions affecting the stock prices. Let’s discuss them one by one in detail.
Bonus Shares
These are extra shares awarded 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. This activity is usually undertaken to help increase the liquidity of the stock. When the price of a stock is high, many retail investors may find it difficult to invest in that company. By issuing bonus shares, the total number of shares of the company increases, thus reducing its share price and making it accessible to more investors.
Hence, it is not advisable to invest in 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 to raise more capital. It could either be for debt reduction or to finance the company’s expansion.
For instance, in a 1:5 rights issue, shareholders can purchase one extra share for every five they currently own. These additional shares are typically available at a reduced price. Before participating, it’s essential to understand the purpose behind the rights issue and assess factors like the company’s earnings outlook and management credibility.
Stock Split
As the name suggests, stock split means splitting a stock into two more equal portions. Stock splits are normally announced by companies so that they can make their shares affordable to small retail investors and hence 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.
Consider a scenario where a company announces a stock split at a ratio of 1:5, with the current face value of the stock being ₹10. Prior to the split, the individual owned 20 shares. Following the split, the shareholding would increase to 100 shares, with each share now having a face value of ₹2. Despite the increase in the number of shares held, the total investment amount remains unchanged.
Dividends
A dividend is a form of regular income paid to shareholders by a company out of its profits and reserves. Dividends may also be given out when a company does not find any appropriate investment opportunity to deploy its funds, and can rather share its profits/reserves with the shareholders to garner and sustain their trust.
A dividend is typically expressed either as a fixed amount per share or as a percentage of the face value of the share. For instance, if XYZ Limited declares a dividend of ₹40 per share with a face value of ₹10, the dividend payout stands at 400%. Regarding tax implications, investors are exempt from taxes on dividend income up to ₹10,00,00. Beyond this threshold, a tax rate of 10% applies. Additionally, companies are liable to pay a Dividend Distribution Tax (DDT) at a rate of 20.93%.
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. A buyback usually signals a company’s confidence in itself, and typically does signal a rise in the share price.
Conclusion
Understanding the effects of corporate actions is important for one to develop as a smart and aware investor. On the one hand, where the rights issue may drive the share price down, the buyback of shares may create a sudden spike in the share price. Analysts and stock experts, carefully inspect these corporate actions and try to figure out the reason for the stock price change along with their sustainability. When it comes to identifying a company’s financial health, one can always reach out to us, Share India, for any financial advice.
