A corporate action is initiated by the board of directors and approved

Corporate Action and its Impact

 

Corporate actions are initiatives taken up by a corporate entity that bring 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.

 

We will be looking into the four 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.

 

 

Dividends

 

Dividends are paid by the company 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.

 

It is not mandatory to pay out the dividends every year. If the company feels that instead of paying dividends to shareholders they are better off utilizing the same cash to fund new project for a better future, then 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 growth opportunities for the company 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 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 the date on which 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 record date is at least 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.

 

Dividend Payout Date: This is the day on which 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.

 

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.

 

 

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.

 

Similar to the dividend issue there is a bonus announcement date, ex bonus date, and record date. Companies 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 shares. By issuing bonus shares, the number of outstanding shares increases, but the value of each share reduces.

 

 

Stock Split

 

The word stock split- for the first time sounds weird but this happens on a regular basis in the markets. What this means is quite obvious – the stocks that you hold actually are split!

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

 

 

Rights Issue

 

The idea behind a rights issue is to raise fresh capital. However instead of going public, the company approaches their existing shareholders Think about the rights issue as a second IPO but for a select group of people. The rights issue could be an indication of a promising new development in the company. The shareholders can subscribe to the rights issue in the proportion of their share holding. For example 1:4 rights issue means for 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.

 

 

Buyback of shares

 

A buyback can be seen as a method for company 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 method of corporate restructuring.

 

There could be many reasons why corporate 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 buy back, it signals the company’s confidence about itself. Hence this is usually a positive for the share price.

 

 

The Key Takeaways:

 

1. Corporate actions has an impact on stock prices

2. Dividends are means of rewarding the shareholders. Dividend is announced as a percentage of 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 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. Rights issue is way through which the company raises fresh capital from the existing shareholders. Subscribe to it only if you think it makes sense

7. Buy back signals a positive outlook of the promoters. This also conveys to the shareholders that the promoters are optimistic of the company’s prospects