Five Corporate Actions and Its Impact on Stock Prices

11.1 – Overview

Corporate actions are initiatives taken up by a corporate entity that brings in a change to its stock. There are many types of corporate actions that an entity can choose to initiate. A good understanding of these corporate actions gives a clear picture of the company’s financial health and determines whether to buy or sell a particular stock.

This chapter will be looking into the five most important corporate actions and their impact on stock prices.

A corporate action is initiated by the board of directors and approved by the company’s shareholders.

11.2 – Dividends

The company pays dividends to its shareholders. Dividends are paid to distribute the profits made by the company during the year. Dividends are paid on a per-share basis. For example, during the financial year, 2012-13 Infosys had declared a dividend of Rs.42 per share. The dividend paid is also expressed as a percentage of the face value. In the above case, the face value of Infosys was Rs.5/- and the dividend paid was Rs.42/- hence the dividend payout is said to be 840% (42/5).

It is not mandatory 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.

Besides, the dividends need not be paid from the profits alone. If the company has made a loss during the year, but it does hold a healthy cash reserve, then the company can still pay dividends from its cash reserves.

Sometimes distributing the dividends may be the best way forward for the company. When the company’s growth opportunities have exhausted, and the company holds excess cash, it would make sense for the company to reward its shareholders, thereby repaying the trust the shareholders hold in the company.

The decision to pay a dividend is taken in the Annual General Meeting (AGM) during which the directors of the company meet. The dividends are not paid right after the announcement. This is because the shares are traded throughout the year, and it would be difficult to identify who gets the dividend and who doesn’t. The following timeline would help you understand the dividend cycle.

Dividend Declaration Date: This is the date on which the AGM takes place, and the company’s board approves the dividend issue

Record Date: This is when the company decides to review the shareholders register to list down all the eligible shareholders for the dividend. Usually, the time difference between the dividend declaration date and the record date is 30 days.

Ex-Date/Ex-Dividend date: The ex-dividend date is normally set two business days before the record date. Only shareholders who own the shares before the ex-dividend date are entitled to the dividend. This is because, in India, the normal settlement is on a T+2 basis. So for all practical purposes, if you want to be entitled to receive a dividend, you need to ensure you buy the shares before the ex-dividend date.

Dividend Payout Date: This is when the dividends are paid out to shareholders listed in the register of the company.

Cum Dividend: The shares are said to be cum dividend till the ex-dividend date.

When the stock goes ex-dividend, usually the stock drops to the extent of dividends paid. For example, if ITC (trading at Rs. 335) has declared a dividend of Rs.5. On ex-date, the stock price will drop to the extent of dividend paid, and as in this case, the price of ITC will drop down to Rs.330. The reason for this price drop is because the amount paid out no longer belongs to the company.

Dividends can be paid anytime during the financial year. If it’s paid during the financial year, it is called the interim dividend. If the dividend is paid at the end of the financial year, it is called the final dividend.

11.3 – Bonus Issue

A bonus issue is a stock dividend, allotted by the company to reward the shareholders. The bonus shares are issued out of the reserves of the company. These are free shares that the shareholders receive against shares that they currently hold. These allotments typically come in a fixed ratio such as 1:1, 2:1, 3:1, etc.

If the ratio is 2:1 ratio, the existing shareholders get 2 additional shares for every 1 share they hold at no additional cost. So if a shareholder owns 100 shares, he will be issued an additional 200 shares, so his total holding will become 300 shares. When the bonus shares are issued, the number of shares the shareholder holds will increase, but an investment’s overall value will remain the same.

To illustrate this, let us assume a bonus issue on different ratios – 1:1, 3:1 and 5:1

There is a bonus announcement date, ex-bonus date, and record date similar to the dividend issue.

Companies issue bonus shares to encourage retail participation, especially when the company’s price per share is very high, and it becomes tough for new investors to buy shares. By issuing bonus shares, the number of outstanding shares increases, but each share’s value reduces, as shown in the example above. The face value remains unchanged.

11.4 – Stock Split

For the first time, the word stock split sounds weird, but this happens regularly in the markets. What this means is quite obvious – the stocks that you hold actually are split!

When the company declares a stock split, the number of shares held increases, but the investment value/market capitalization remains similar to the bonus issue. The stock is split concerning the face value. Suppose the stock’s face value is Rs.10, and there is a 1:2 stock split then the face value will change to Rs.5. If you owned 1 share before the split, you would now own 2 shares after the split.

We will illustrate this with an example:

Like a bonus issue, a stock split is usually to encourage more retail participation by reducing the value per share.

11.5 – Rights Issue

The idea behind a rights issue is to raise fresh capital. However, instead of going public, the company approaches its existing shareholders Think about the rights issue as a second IPO and a select group of people (existing shareholders). The rights issue could be an indication of promising new development in the company. The shareholders can subscribe to the rights issue in the proportion of their shareholding. For example, 1:4 rights issue means every 4 shares a shareholder owns; he can subscribe to 1 additional share. Needless to say, the new shares under the rights issue will be issued at a lower price than what prevails in the markets.

However, a word of caution – The investor should not be swayed by the company’s discount, but they should look beyond that. A rights issue is different from a bonus issue as one is paying money to acquire shares. Hence the shareholder should subscribe only if he or she is completely convinced about the company’s future. If the market price is below the subscription price/right issue price, it is obviously cheaper to buy it from the open market.

11.6 – Buyback of shares

A buyback can be seen as a company’s method to invest in itself by buying shares from other investors in the market. Buybacks reduce the number of shares outstanding in the market; however, buyback of shares is an important corporate restructuring method. There could be many reasons why corporates choose to buy back shares…

1. Improve the profitability on a per-share basis
2. To consolidate their stake in the company.
3. To prevent other companies from taking over.
4. To show the confidence of the promoters about their company.
5. To support the share price from declining in the markets.

When a company announces a buyback, it signals the company’s confidence about itself. Hence this is usually positive for the share price.

Key takeaways from this chapter

1. Corporate actions have an impact on stock prices.
2. Dividends are a means of rewarding shareholders. The dividend is announced as a percentage of the face value.
3. If you aspire to get the dividend, you need to own the stock before the ex-dividend date.
4. A bonus issue is a form of the stock dividend. This is the company’s way of rewarding the shareholders with additional shares.
5. A stock split is done based on the face value. The face value and the stock price changes in proportion to the change in face value
6. A rights issue is a way through which the company raises fresh capital from the existing shareholders. Subscribe to it only if you think it makes sense
7. Buyback signals a positive outlook of the promoters. This also conveys to the shareholders that the promoters are optimistic about the company’s prospects.