Corporate actions is any initiative taken up by the company’s board of directors to bring material changes to an organization and impacts its stakeholders. If you are a trader or investor considering buying shares of the company, then you need to understand how corporate actions will affect the company’s stock price.
A good understanding of these corporate actions can help you to decide whether to buy or sell a particular stock or to remain invested.
In this article, we will be discussing different corporate actions and its impact on stock prices.
Dividends
Dividends are paid to the shareholders by the company out of the profit made by the company for a financial year.
For example, if the company has made a good profit for the financial year 2021-22, then the board of directors might decide to pay a dividend to the shareholders on a per share basis. Assume for a moment you are holding 100 shares of that company and the board of directors have decided to pay Rs. 5 per share as dividend. In this case, you will receive Rs 500 as dividend to your bank account from the company.
It’s not mandatory for companies to pay dividends to shareholders. To understand how a dividend is paid by the company to shareholders, you need to understand the dividend cycle.
Now the important question is how dividends affect stock price.
After declaring a dividend, the company decides the record date based on which ex-dividend date is arrived, which is 2 business days prior to the record date.
When stock goes ex-dividend, the share price generally drops to the extent of dividends paid. For instance, in our above case, the company has declared Rs. 5 as dividend per share, which means company’s share price might get corrected by Rs. 5 per share on ex-dividend date.
When a growth stock starts to issue dividends, many market participants might conclude that the company that was rapidly growing is settling down for a stable but unspectacular rate of growth.
Bonus Issue
To reward its shareholders the company might issue bonus shares instead of paying dividends. Bonus shares are free shares issued out of the company’s reserve and surplus.
Bonus shares are issued in a fixed ratio decided by the company such as, 1:1, 1:2, 3:1 etc.
If the company has decided to issue bonus shares in a fixed ratio of 1:1, then the existing shareholders get one additional free share of the company for every 1 share they hold. So if you are holding 100 shares of the company, then you will get another 100 shares with no additional cost, so your total holding will become 200 shares.
When a company decides to pay bonus shares, it also decides the ex bonus date and record date.
After bonus issue, the number of outstanding shares increases by the number of additional free bonus shares issued to shareholders and value of each share reduces based on the fixed ratio.
In our above example the fixed ratio for bonus issue was 1:1, therefore, outstanding shares will be doubled and share price will be adjusted accordingly based on the market price of the share.
Stock Split
In stock split, the company decides to split the share with reference to the face value of share.
Suppose the face value of the stock is Rs. 100, and the company has decided to split it in the fixed ratio of 1:10, then the face value of the stock will be changed to Rs. 10. After the stock split if your earlier holding was 10 shares @ 100 each, then it will become 100 shares @ 10 each. Your market value of holding will not change as the market price and number of shares will get adjusted based on the stock split ratio decided by the company.
A one-for-one stock split is most common. This means if you are holding one share of the company, then automatically you will own two shares, each worth exactly half the price of the original share.
Similar to bonus issues, when a company declares stock split, the number of outstanding shares increases but the market capital remains the same.
Stock split is generally done to allow retail participation.
Rights Issue
Instead of going public to raise capital, the company might decide to approach their existing shareholders. If they have decided to raise capital from existing shareholders, then they declare the right issue in a fixed ratio such as 1:1, 1:2, 3:1 etc.
Interested shareholders can participate in the right issue in the proportion of their shareholding. For instance if the right issue is in the ratio of 1:1, it means for every 1 share a shareholder owns, he can subscribe to 1 additional share.
The main difference between a right issue and bonus issue is that, in bonus issues, the company gives free shares to shareholders out of its reserve and surplus. However, in the right issue the company wants money from shareholders in exchange for additional shares.
Buyback of shares
Buyback is a method in which a company buys back its own share from existing shareholders in the market. As a company buys its own share, the outstanding number of shares in the market reduces.
Usually, company gives buyback offer at a premium to the current market price of the stock in order to reward its shareholders.
Here are few possible reason why a company might decide to go for buyback of shares;
- To improve earning per share of the company
- To consolidate their own stake in the company
- To show promoter’s confidence about the future of their company.
- To support the share price from declining in the markets.
Companies communicate their corporate action to the shareholders. You can also track corporate actions by visiting the official website of NSE and BSE.
