Effects of Dividends, Bonus Issue, Stock Splits, Buybacks and Rights Issues on Stock Prices

When you invest in stocks, understanding how corporate actions impact stock prices is essential. Corporate actions are decisions made by a company’s board of directors that can affect shareholders, their investment value, and the company’s stock price.

These actions include dividends, bonus issues, stock splits, buybacks, and rights issues. Each of these actions has a different impact on the stock price and your investment, and knowing how they work can help you make informed decisions when buying or selling shares.

In this detailed guide, we’ll break down each type of corporate action, explain how it works, and how it affects stock prices.

Dividends – A Way to Earn Income from Your Investment

Dividends are cash payments that a company makes to its shareholders, usually from its profits. If you own shares in a company that declares a dividend, you will receive a portion of the company’s profits based on how many shares you own. 

For example, if XYZ Industries declares a dividend of ₹42 per share, owning 100 shares would give you ₹4,200.

Dividend Payout Ratio

The dividend is usually a percentage of the stock’s face value.

For example, if a ₹42 dividend is declared on a ₹5 face value share, this represents an 840% payout.

Dividend Cycle:

• Declaration Date: The date the company announces the dividend.
• Record Date: The date when the company checks its shareholder register to determine who is entitled to receive the dividend.
• Ex-Dividend Date: The date by which you need to own the stock to qualify for the dividend. If you purchase the stock on or after this date, you won’t receive the upcoming dividend.
• Payout Date: The date when the dividend is actually paid to shareholders.

Impact on Stock Price:

When a stock goes ex-dividend, its price generally drops by the amount of the dividend. For example, if XYZ Industries declares a ₹15 dividend and the stock is trading at ₹335, the price may drop to ₹320 after it goes ex-dividend, reflecting the outflow of cash from the company.

Bonus Issues – More Shares, Same Value

A bonus issue occurs when a company issues additional shares to existing shareholders for free, instead of paying a cash dividend. The bonus shares are typically issued from the company’s reserves.

The ratio for bonus issues is usually expressed as a proportion. For example, a 1:1 bonus issue means that for every share you already own, you will receive one additional share.

Key Points About Bonus Issues:

• No Cash Outflow: You receive additional shares, but you don’t have to pay for them. This is simply a reallocation of the company’s reserves into shareholder equity.
• Total Investment Value Unchanged: Even though the number of shares increases, the total value of your investment remains the same, as the price per share adjusts accordingly.

Example: Before the bonus issue, you might own 100 shares priced at ₹75 each, for a total value of ₹7,500. After a 1:1 bonus issue, you would own 200 shares, but the new price per share would adjust to ₹37.50. The total value of your holding would still be ₹7,500.

Stock Splits – Lower Price, More Shares

A stock split happens when a company divides its existing shares into multiple new shares. This reduces the price of each share but increases the number of shares outstanding.

For example, in a 2-for-1 stock split, the company gives you two shares for every one share you already own, but the price per share is halved.

Key Points About Stock Splits:

• Impact on Ownership: Your ownership in the company remains the same. If you had 100 shares before the split, you would now have 200 shares.
• Total Value Unchanged: The overall value of your investment remains the same because although the price per share is lower, the number of shares you own increases.

Example: Before the stock split, you might own 100 shares priced at ₹900 each, for a total value of ₹90,000. After a 1:2 stock split, you would own 200 shares, but each share would now be worth ₹450. The total value of your investment remains ₹90,000.

Why Companies Do Stock Splits:

• To make the stock price more affordable to a larger number of investors.
• To increase liquidity by having more shares available for trading.

Rights Issues – Buying New Shares at a Discount

A rights issue is a way for companies to raise capital by offering new shares to existing shareholders at a discounted price. The company might offer one new share for every four shares you already own, at a price lower than the current market price.

Key Points About Rights Issues:

• Eligibility: Only existing shareholders are eligible to buy the new shares.
• Discounted Price: The new shares are offered at a price below the current market value, which is attractive for investors.
• Optional Purchase: Shareholders can choose to buy the new shares at the discounted price or sell their rights to buy shares to someone else.

Example: If a company offers a 1:4 rights issue, you could buy one additional share for every four shares you already own at a discount to the market price. If the stock is trading at ₹100, the rights issue might offer the new shares at ₹80 each.

Considerations Before Buying in a Rights Issue:

• Evaluate the Need: Companies usually do rights issues to raise funds for expansion or pay off debt. This might be a sign of growth, but it could also signal financial trouble.
• Market Price vs. Rights Issue Price: If the market price of the stock is lower than the rights issue price, it may be better to buy shares on the open market rather than through the rights issue.

Buybacks – When Companies Repurchase Their Own Shares

A buyback occurs when a company buys back its own shares from the market. This can be a positive signal to investors, as it shows the company believes its shares are undervalued.

Key Points About Buybacks:

• Increase in Earnings Per Share (EPS): Reducing the number of shares outstanding boosts the earnings per share, even if the company’s overall earnings don’t change.
• Consolidating Control: Companies may buy back shares to reduce the risk of hostile takeovers by reducing the number of shares available on the open market.
• Supporting Stock Price: In tough market conditions, companies may repurchase shares to help stabilize or increase the stock price.

Example: If a company buys back 1 million of its shares, the remaining shares in circulation decrease, making each remaining share slightly more valuable. This can lead to a rise in the stock price.

Why Companies Do Buybacks:

• To demonstrate confidence in their future prospects.
• To improve financial metrics like earnings per share.
• To prevent hostile takeovers or maintain control over the company.

Corporate actions such as dividends, bonus issues, stock splits, buybacks, and rights issues can significantly impact stock prices and your investment portfolio.

By understanding how these actions work, you’ll be better equipped to make informed decisions, whether you’re holding, buying, or selling stocks. 

These actions give you a deeper insight into a company’s financial health and strategy, and staying aware of them can help you become a more knowledgeable and successful investor.

By keeping an eye on corporate actions, you can enhance your investment strategy and manage your portfolio more effectively.