Understanding Corporate Actions And It’s Impact On Stock Prices

3 min read

Positive or negative, big or small, every corporate action can impact a companies’ share price. In our previous post we have discussed the external factors which affect the stock prices, and in today’s post we will discuss the Corporate Actions, Types of Corporate Actions and its effects on Stock Prices. 

Investors should know what corporate actions are and what effect it would bring about in your investments. This would not only help you to understand the share price movement but also to strategize the holdings accordingly.

What are Corporate Actions?

A corporate action is an initiative taken by the management of companies or a board in 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, stock splits are some of the common examples of mandatory corporate actions. Optional dividends, tender offers, right issues are examples of voluntary actions.

Some Popular Corporate Actions That You Should Know

Bonus Shares, Rights Issue, Dividend, Share Buyback, Stock Splits are common but severely impacting corporate actions affecting the stock prices. Let’s discuss them one by one in detail.

  1. 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 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.

  1. 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 example, a 1:5 rights issue implies that you are entitled to buy one additional share for every five shares that you hold.These fresh shares are offered to existing shareholders at a discounted price. Do read through the reason for the rights issue before you opt for it, also make sure the company has a strong earnings visibility and a credible management system.

  1. 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 makes 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.

 Let’s understand it with a suitable example: A company declares a stock split of 1:5 and the face value of the stock is Rs 10. Before splitting, you held 20 shares, after the split, you will hold 100 shares as the face value will change to Rs 2 per share. There is an increase in the number of shares but the amount invested remains the same.

  1. 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 usually quoted per share or as a percentage of the face value of the share. For example, XYZ limited company had declared a dividend of Rs 40 per share, whose face value was Rs 10, then the dividend payout is 400%.

If we talk about the tax implications on dividend income, then investors need not pay any tax up to Rs 10,00,00. i.e Income from dividends is tax-free in the hands of investors up to Rs 10,00,00 and beyond then the tax is levied @10%. Companies are also expected to pay a Dividend Distribution Tax (DDT) at 20.93%.

  1. 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.

Takeaway

Understanding the effects of corporate actions is important for you 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.

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