Corporate actions are the decisions taken up by a company or an entity that often results in a change in its stock price. There are many sorts of corporate actions that an entity can prefer to initiate. An honest understanding of these corporate actions gives a transparent picture of the company’s financial health, and also to work out whether to buy or sell a specific stock.
Now, that we have briefly discussed the general stock market terms (read here). Here, we’ll be looking into the five most significant corporate actions and their impact on stock prices.
A corporate action is initiated by the company’s board of directors post-approval of its shareholders.
1 – Dividends
Dividends are paid by the corporate to its shareholders to distribute the profits made by it during the year on a per-share basis. For instance, last fiscal year, Coal India had declared a dividend of Rs.13.1 per share. The dividend paid is expressed as a percentage of the face value.
In the above case, the face value of Coal India was Rs.10/- and therefore the dividend paid was Rs.13.1/- hence the dividend payout is 131% (131/10).
It is not mandatory to disburse the dividends each year. If the company feels that rather than paying dividends to shareholders they are at an advantage utilizing this cash to fund a new project for a far better future, they can do so. Besides, the dividends don’t need to be paid from the profits alone. If a company has made a loss during the year but it holds a healthy cash reserve, then it can still pay dividends from its cash reserves.
Sometimes distributing the dividends could also be the simplest way forward for the corporate. When the growth opportunities for the company have exhausted and also the company holds excess cash, it would add up for the entity to reward its shareholders thereby repaying the trust the shareholders hold within the company.
The decision to pay a dividend is taken within the Annual General Meeting (AGM) during which the administrators of the corporate meet. The dividends aren’t paid right after the announcement. This is often because the shares are traded throughout the year and it might be difficult to spot who gets the dividend and who doesn’t, the subsequent timeline would assist you understand the dividend cycle.
Dividend Declaration Date
This is the date when the Annual General Meeting (AGM) takes place and the company’s board approves the dividend value & its issue.
The date when the company decides to review the shareholders’ list to mention all the eligible shareholders for the dividend. Usually, the time difference between the declaration date and the record date is a minimum of 30 days.
The ex-date is normally set two business days before the record date. Only shareholders who own the shares before the ex-date are entitled to get the dividend. So for all practical purposes if you want to be entitled to get dividends you need to ensure that you buy the stocks before this date.
Dividend Payout Date
This is the day on which the dividends are paid out to all the listed shareholders as per the company’s record.
The shares are said to be cum dividend till the ex-dividend date.
When the stock goes ex-dividend, usually the price drops up to the value of dividends paid. For example, if Coal India (trading at Rs. 135) has declared a dividend of Rs.13, on the ex-dividend date the stock price will drop to the extent of dividend paid, and as in this case, the price of Coal India will drop down up to Rs.122.
The reason behind this drop is because the amount paid out by the company no longer belongs to it.
Dividends can be paid anytime during the fiscal year. If it’s paid within the financial year it is known as interim dividend. However, If the dividend is paid at the end of the year it is termed as a final dividend.
2 – Bonus Issue
A bonus issue is a kind of share dividend, allocated by the company to reward its shareholders. The bonus shares are issued out of the company’s reserves. These are bonus shares that the shareholders receive against quantity shares currently held by them. These allotments come in a fixed ratio such as 1:1, 3:1, etc.
If the ratio is 3:1, the existing shareholders get 3 additional stocks for every 1 share held at no additional cost. So if a shareholder owns 10 shares then he will be issued an additional 30 shares, so his total holding will now be 40 shares. When the bonus shares are issued, the number of shares the shareholder holds increases but the overall value of investment remains the same.
Similar to the dividend there is a bonus announcement date, ex-bonus date, and record date.
Corporates issue bonus shares to encourage retail participation, especially when the price per
share of a company is very high and it becomes tough for new investors to buy individual shares. By issuing bonus shares, the number of outstanding shares increases, but the value of each share reduces as discussed above but the Face value of each share remains the same.
3 – Stock Split
The word stock split sounds weird but it happens regularly in the stock market. What this means is quite obvious – the stocks that you hold gets split based on its FV.
When a stock split is declared by the company, the number of shares held by the shareholder increases but the investment value/market capitalization remains the same similar to the bonus issue. The only difference between the two (bonus & split) is the Face value. Suppose the stock’s face value is Rs.2, and there is a 1:1 stock split then the face value will change to Rs.1. If you own 1 stock before split you would now own 2 stocks post-split.
Similar to the bonus issue, a stock split is also to encourage more retail participation by reducing
the price value per share.
4 – Rights Issue
The idea behind a rights issue is to raise fresh capital investment. However, instead of going public, the company reaches to its existing shareholders. In simple terms, the rights issue can be understood as a second IPO but for selected individuals i.e existing shareholders.
The rights issue could indicate a promising new development in the company. The shareholders can subscribe to such rights issues in the proportion of their shareholding. For example, 1:2 rights issue means for every 2 shares held by the shareholder, 1 additional share can be subscribed. It can be worth to state that the new shares under the rights issue will be issued at a discounted price than its then-current value in the markets.
However, as a caution – The investor should not be swayed by the discount offered but they should look beyond that. The rights issue is different from the bonus issue as one pays money to acquire shares. Hence the shareholder should subscribe only if he or she is completely convinced regarding the company’s future. Also, if the market price is below the subscription price/right issue price it is wiser to buy stock from the open market.
5- Buyback of shares
A buyback is a process for a company to invest in itself by buying its shares from other investors in the market. Buyback reduces the number of outstanding stocks in the market. However, share buyback is also an important technique of corporate restructuring.
There could be many reasons why companies choose to buy back:
1. Improve profitability per share.
2. To amalgamate their stake in the company
3. To prevent other companies from taking over control.
4. To show promoters confidence about their entity.
5. To support the declining share price.
In any case, if a company announces a buyback, it signals the company’s confidence in itself. Hence it usually has a positive impact on the share price.