Investing 101

Corporate Actions , types of Corporate Actions and its effect on Stock Prices.

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 Retail Investors like you and me 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.

So let’s go on with it.

What is a Corporate Action?

A corporate action is any 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; 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.

What are the effects of Corporate Actions on the share prices?

Bonus Shares: These are additional shares gifted by a company to its shareholders. A 1:1 bonus issue implies that 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 profits or reserves.But 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. So, in a 1:1 bonus issue, the share price will fall by 50%. Other metrics, such as earnings per share (EPS), will also go down. However, over the long term, and as stock price increases, investors tend to gain. There is no tax on allotment of bonus shares. Bonus issues are generally an indicator of a company’s good health and show that its earnings would rise over the next 2-3 years.

We Indians love free things so free shares is not an exception and thus there’s increased interest in buying shares of companies after they announce bonus shares , but 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 buying its shares.

Impact : The share price falls in the same  proportion as the bonus issue ratio.

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— 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 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 check out the reason for rights issue before you opt for it, also make sure the company has a strong earnings visibility and a credible management. The tax treatment is similar to that of bonus shares.

Impact : The share price falls 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 make them more liquid. Once liquidity increases, more buyers and sellers trade in the stock, which, in turn, helps discover its true value.

The stock is split keeping in mind its face value—not market value. For instance, if the stock’s face value is Rs 10, and there is a 1:1 split, its face value will change to Rs 5. Accordingly, the 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). In the below case Face value of 10 was divided into 10 shares of 1 rupee face value each.

Impact : The share prices gets slashed in the accordance with the stock split ratio.

Dividends:Dividends 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. Dividend is usually quoted per share or as a percentage of the face value of the share. For instance, 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 required to pay a Dividend Distribution Tax (DDT) at 20.93%.

Impact : Share price usually declines in line with the level of dividend paid per share.

Buyback of Shares: It 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 enterprise and for greater control, to support the share price from declining, to improve earnings per share (as it reduces 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: Merger 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 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 Share.

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 often sell less productive or unrelated subsidiary businesses as spin-offs. A company might 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 worth more as independent entities than as parts of a larger business.

In a complete spinoff, the stock price of the company right before the spinoff should theoretically be 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.

I hoped you liked this article. Do leave me Feedback.

Thanks,

-ASLNK

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6 Comments

  1. […] to the market value of stock. The face value is important with regard to corporate action (Corporate Actions – Meaning , types and effects article link). Usually when dividends and stock split are announced they are issued keeping the face value in […]

  2. VERY LUCID AND ENLIGHTENING INTERPRETATION IN SUCH A SIMPLE MANNER.

    1. Thanks Deepak 🙂

    2. Thanks Deepak 😀

  3. Thank you so much for this article

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