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The Wonderful Impact Of Corporate Action On The Stock Price You Need To Know

Published : May 24, 2019

The Wonderful Impact Of Corporate Action On The Stock Price You Need To Know

A corporate action is an episode by a listed company to bring changes to the securities. Securities may be equity or debt by the issuing public company. Company’s board of directors approves for corporate action after the shareholder’s authorization. Stock splits, dividends, mergers, and acquisitions, rights issues, etc. are the typical corporate action. Thus, to summarize,

  • A corporate action by a listed company influences its shareholder’s value straight.
  • Such corporate action may either be monetary or non-monetary.
  • Payment of dividend to its shareholders is monetary while right issue or issue of bonus to shareholders comes under non-monetary type.

Corporate action for retail investors – Why it matters? 

As of now, it is clear that public company issues or takes corporate action and this influence the stock prices to some extent. As an investor or a shareholder to such company, it is necessary to understand how corporate actions affect the company’s stock. This helps an investor to know about the current financial health of a company and its future prospects. This not only benefits in identifying the short-term expectation from a company but also reflect much on their long term hopes.

Now to make it clear, corporate actions include stock splits, dividends, mergers and acquisitions, rights issues and spin-offs. All of these are major decisions taken by the company’s board of directors and the shareholder’s consent.

The viewpoints one need to consider are regarding corporate action includes – 

  • Issuer’s point of view
  • Shareholder’s viewpoint
  • The viewpoint of any party between or has a relation to the above parties.

Momentarily in the present blog article, I am going to present the shareholder’s viewpoint on some of the main corporate action taken by the public companies. As of now, the other two viewpoints are out of scope from the present article. But before that let us understand the various kinds of corporate action are there.

Kinds of corporate action

The following are the three main types of corporate action which are in fact self-explanatory.

  1. Mandatory corporate action – This action is mandatory for the shareholder to participate. They do not have any other choice. Although these actions are often subject to shareholders’ approval. Cash dividend, stock splits, mergers, pre-refunding, the return of capital, bonus issue, asset ID change, and spin-offs are examples of mandatory corporate action.
  2. Voluntary corporate action – This is a voluntary action for shareholders saying that they can elect and make their choice known by sending an instruction. Shareholders can choose to take no actions. This can lead their securities unaffected. Tender offer or public takeover bid, rights issue and making buyback offer to the shareholders while delisting the company comes under voluntary corporate action.
  3. Mandatory corporate action with options – This event is mandatory but can be presented with options. The rule that applies here is if the shareholder does not make his choice then it can be considered as the default option.  Cash or stock dividend option is an example of mandatory corporate actions with options.

Importance of corporate action

The following are the purpose of the corporate action –

  1. Corporate restructuring- Corporate actions are taken to increase the company’s profitability. Few examples are like, Spinoff, Mergers, and Acquisitions. 
  2. Impacting share price- The liquidity of stocks are widely impacted if the stock price is too high or low. If the stock price is too high, then there is a question mark on affordability to all investors. Whereas, if the prices are low then we see it as a bad investment.
  3. Distributing profit to shareholders- The distribution of dividend can be in the form of cash or stock. In the case of cash, the company declares to pay the dividend on each outstanding share. Hence, the bonus issue includes an issue of additional shares to shareholders instead of cash.

Impact of corporate action on shareholders value

As an owner of the company’s stock, you can measure the impact of corporate action in terms of changes to the securities and/or cash positions. Thus, any corporate actions impact your value of ownership in the following two ways –

  • Benefits – Some corporate action results in an increase in the position holder’s securities or cash position, without altering the underlying security. For instance, take the example of bonus issues. In bonus issue, you receive additional shares in proportion to your holdings.
  • Reorganizations – Some other corporate action reshapes or restructures your’s underlying securities position, that may sometimes result in a cash payout. As an example, equity restructures, conversions, and subscriptions.

Types of corporate action with examples

1. Dividend corporate action 

Dividends are paid by the company to its shareholders. These are paid to distribute profits made by the company during the year. The company pays dividends on the basis of per share. Although, it is not mandatory for the company to pay out dividends every year. If the company feels that instead of paying dividends to shareholders they are better off utilizing the same cash to fund a new project for a better future, they can do so.

In the case of corporate action, the dividend is a mechanism through which the company shares the profits with its investors. This can be in the form of a cash dividend or a stock dividend. These are issued at a specified interval of time. It can quarterly, semi-annually or yearly or a combination of all. There is a reduction in the company’s equity when there is a distribution of dividends. The price of share gets reduced by the amount of dividend. For example, if the share is trading at INR 100 and company declares a dividend of INR 2 per share, so on the day when the dividend is distributed, the price of share post dividend will trade at INR (100-2) i.e. INR 98.

Whereas, in the case of a stock dividend, the shareholder gets additional shares. Illustration, when the company declares a stock dividend of 20%. This means that for every 10 shares held, the shareholder gets two additional shares. Since it increases the shares outstanding by diluting the earnings per share, so it led to a decrease in the share price. 

From an investment point of view on such good dividend-paying stocks, you need to keep track of such stocks. Here Rmoney comes handy. We publish a list of dividend-paying Indian stocks on our website regularly. You can analyze stocks for your portfolio from there.

2. Bonus issue corporate action

These are the shares that a company offers to its shareholders as a gift. Here a rule applies of 1:1 bonus issue. Further meaning is that the shareholders get one additional share for each share that they are already holding. Normally, when a company confronts liquidity issues or is not in a position to distribute the dividends, then they tend to issue bonus shares out of its profits or reserves.

In case of bonus shares, the price of the shares of the company falls in the same proportion as compared to the bonus share issued. Therefore, in a 1:1 bonus issue, the share price will fall by 50%. The metric like earnings per share will also lower down. Anyhow, in the long term as the stock prices increases, investors tend to gain. The positive part is that there is no tax on the allotment of bonus shares. Bonus shares indicate the good health of a company. It also shows that earnings will rise over the next  2-3 years.

The investors show more interest in buying the shares of the company that shows bonus shares. Usually, the experts are against investing the company offering bonus shares in just the sake of additional shares. One needs to check the recent earnings of the company as well as growth, capital expenditure, etc.  

You can get the list of latest bonus issues in India on Rmoney India website for your analysis purpose.

3. Right issues corporate action

It is a corporate action event where a company seeks to increase its capital by issuing new securities. The existing shareholders are given a chance to maintain their stake in the company in order to prevent dilution. Therefore, the rights are credited to existing shareholders of a company. The rights are nothing but the securities just like shares and can be listed on a stock exchange. There is a predetermined trading period to trade the right issues. During the exercise period, the right issues can be exercised to subscribe to new securities. On the payment date, shareholders will receive inducing securities. They will then pay the company the exercised price per share. The non-exercised rights, if not used, will lapse.

In right issues, there are fresh shares that a company issues to its existing shareholder. The major dissimilarity between bonus share and the right-issue is that the investors need to pay for these issues. The prices are usually discounted. Further illustrations say, a 1:5 right-issue implies that the investors will get to buy one additional share for every five shares they hold. Mostly, Cash trapped companies turn to a rights issue to raise money. The major impact can be that the share price falls in the same proportion as the rights issue.

4. Stocks split corporate action

When we hear stock splits for the first time it sounds like something weird but it takes place on a regular basis. The stock split is a situation where a  company can decide to increase the number of its outstanding shares. While at the same time decreasing the nominal share proportionally. In simple words, it means the stock that the investor hold actually will split.

After a stock split the number of shares you hold will increase. But the investment in the value or the market capitalization is constant. It is as similar to the bonus issue. Companies do the stock split with reference to the face value. Now, let’s suppose the face value of the stock is INR 10. Further, the company announces for the stock split in the ratio of 1:2. Then the face value will change to INR 5. If the investor owns one share before the split, then they will now own two shares after the split.

The stock split is an action that the corporate takes as corporate actions. Here, a company divides its existing shares into multiple shares. Usually, the companies get into the splitting process to lower the trading price of their stock. This is to a range deemed comfortable by most investors and increases the liquidity of the shares. Therefore, when a company’s share price rises significantly, most public firms will stop to declare stock split. It is to reduce the price to a more popular trading price. Although the number of shares outstanding increases during a stock split. The total dollar value of the shares remains the same compared to pre-split amounts because the split does not add any real value.

5. Buyback corporate action

Firstly, the concept of buyback denotes that it is a method that a company uses to invest in itself. Next, the companies do this by buying shares from other investors in the market. Thus, buyback decreases the number of shares that are outstanding in the market. However, this method of buyback plays a vital role in corporate restructuring.

There can be reasons why corporate chooses to buy back shares:-

  1. Help refine the profitability on a per share basis
  2. Aid integrate their stake in the company
  3. Serves to intercept other companies from taking over
  4. To show the confidence of the promoters about their company
  5. Assist to support the share price from declining in the markets

Buyback is the positive sign for the share price. This is the signal of the company’s confidence in itself.

The takeaway lesson from corporate action

  • Corporate actions have a major impact on stock prices.
  • Dividends are the medium to reward the shareholders. Companies declare divided as a percentage of face value.
  • If the investor has a desire to get a dividend then one should own the stock before the ex-dividend date.
  • The bonus issues are one of the forms of the stock dividend. It is a reward, a company gives to its shareholders as an additional share.
  • The stock split is done on the basis of face value. The face value and the stock price changes in proportion to the change in face value
  • The rights issues are a suitable way through which a company raises fresh capital from existing shareholders.
  • Buyback is the signal of the positive outlook of the promoters. This also conveys to the shareholders that the promoters are optimistic of the company’s prospects.

Where to find information on corporate action?

We at Rmoney India website under market intelligence section publishes nearly all information on corporate action that might be of retail investors interest. Some general corporate action you will find in the left side panel of the page. A more company-specific corporate action details you will find on the company-specific page on the same section. Besides, all three stocks exchanges have a page on corporate action. Further, each one of them has a detailed list of corporate action as a filter.

NSE India on their website shows a page on corporate action. According to the webpage of NSE India, 13 subcategories for corporate action is there under ‘Purpose’ search criteria. They are, bonus, consolidation, call on securities, conversion, dividend, interest, merger, board meeting, reduction in capital, redemption, right, split, and other corporate action.

Similarly, BSE India and Metropolitan Stock Exchange of India have exclusive pages on their website featuring all corporate action.  BSE India has 41 sub-classification while on MSEI you can filter monthly data on corporate action.

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