Corporate actions and impact on stock prices

Corporate actions are events initiated by a company that can impact its stock price.

Having a good understanding of corporate actions can provide valuable insights into a company’s financial health, which in turn can inform investment decisions.

By analyzing corporate actions such as bonus issues, stock splits, dividends, rights issues, and buybacks, investors can gain a clearer picture of the company’s financial situation and make informed decisions about whether to buy, sell, or hold a particular stock.

Corporate actions

The article explains five types of corporate actions that can impact stock prices

Bonus Issue

A bonus issue is when a company issues additional shares to its shareholders at no cost. This increases the number of shares outstanding and reduces the price per share. However, the total value of the shareholder's holdings remains the same.

For example let’s say a company ABC Ltd announces a 1:1 bonus issue, which means that for every share held by an existing shareholder, the company will issue one additional share at no cost. If a shareholder owns 100 shares of ABC Ltd, they will receive an additional 100 shares as a bonus. After the bonus issue, the shareholder will now hold a total of 200 shares, but the value of their holdings remains the same.

Suppose the market price of ABC Ltd.’s stock is Rs. 1,000 before the bonus issue. After the bonus issue, the number of shares outstanding will increase, but the total market capitalization of the company remains the same. Therefore, the market price per share will decrease to reflect the increase in the number of shares outstanding. Suppose the market price per share decreases to Rs. 500 after the bonus issue.

As a result, the shareholder who owned 100 shares of ABC Ltd before the bonus issue would now hold 200 shares, but the total value of their holdings would remain unchanged.

The shareholder’s holdings would now be worth Rs. 1,00,000 (i.e., 200 shares x Rs. 500 per share), the same value as before the bonus issue, despite owning twice the number of shares.

Stock Split

 A stock split is when a company increases the number of shares outstanding by dividing its existing shares. This reduces the price per share, making the stock more affordable for investors. However, the total value of the shareholder's holdings remains the same.

For example, let’s say a company XYZ Ltd announces a 2-for-1 stock split. If an investor owned 100 shares of XYZ Ltd before the split, they would now own 200 shares after the split, but the value of their holdings remains the same.

Suppose the market price of XYZ Ltd’s stock is Rs. 1,000 per share before the stock split. After the split, the total number of shares outstanding will double, but the total market capitalization of the company remains the same.

Therefore, the market price per share will decrease to reflect the increase in the number of shares outstanding. Suppose the market price per share decreases to Rs. 500 after the stock split.

As a result, the shareholder who owned 100 shares of XYZ Ltd before the stock split would now hold 200 shares, but the total value of their holdings would remain unchanged. The shareholder’s holdings would now be worth Rs. 1,00,000 (i.e., 200 shares x Rs. 500 per share), the same value as before the stock split, despite owning twice the number of shares.

Stock splits are often used by companies to make their shares more affordable and increase liquidity in the stock.

The lower price per share can attract more investors, particularly smaller retail investors who may not be able to afford the higher price per share.

A stock split can also increase trading activity in the stock, as investors may buy or sell the stock more frequently after the split.

Rights Issue

A rights issue is when a company offers existing shareholders the right to purchase additional shares at a discounted price. This can dilute the value of existing shares, but if the company uses the proceeds from the issue wisely, it can improve the company's prospects and increase the stock price.

For example, let’s say a company XYZ Ltd announces a rights issue of 1:3, which means that for every three shares owned by an existing shareholder, they have the right to purchase one additional share at a discounted price. Suppose the current market price of XYZ Ltd’s shares is Rs. 1,000 per share, and the rights issue is offered at a discounted price of Rs. 800 per share.

If a shareholder owns 300 shares of XYZ Ltd, they would have the right to purchase 100 additional shares at the discounted price of Rs. 800 per share. The cost of purchasing these additional shares would be Rs. 80,000 (i.e., 100 shares x Rs. 800 per share).

Suppose the shareholder decides to exercise their right to purchase the additional shares. After the rights issue, the shareholder would hold 400 shares of XYZ Ltd, and their total investment in the company would be Rs. 3,20,000 (i.e., 300 shares held before the rights issue valued at Rs. 1,000 per share, plus 100 shares purchased through the rights issue at Rs. 800 per share).

Rights issues are often used by companies to raise additional capital from their existing shareholders.

By offering discounted shares to their current investors, companies can incentivize them to invest more in the company, while also maintaining their current ownership percentage.

Rights issues can also be used to improve the liquidity of the company’s shares, as the additional shares increase the number of shares outstanding.

Dividend

A dividend is when a company distributes a portion of its profits to its shareholders. This can increase the stock price, as investors tend to favor companies that pay dividends. However, the dividend payout reduces the company's profits, which can impact the stock price negatively.

A dividend is a distribution of a portion of a company’s profits to its shareholders. Companies can pay dividends in the form of cash or additional shares of stock.

For example, let’s say a company ABC Ltd announces a dividend of Rs. 5 per share. If an investor owns 100 shares of ABC Ltd, they will receive a dividend of Rs. 500 (i.e., 100 shares x Rs. 5 per share).

Suppose the market price of ABC Ltd.’s stock is Rs. 1,000 per share before the dividend is paid. After the dividend is paid, the market price of the stock may decrease to reflect the reduction in the company’s profits. Suppose the market price per share decreases to Rs. 950 after the dividend is paid.

As a result, the shareholder who owned 100 shares of ABC Ltd before the dividend was paid would receive a dividend of Rs. 500 and would still hold 100 shares after the dividend. The total value of their holdings would decrease to Rs. 95,000 (i.e., 100 shares x Rs. 950 per share), reflecting the decrease in the market price of the stock.

Dividends are often used by companies as a way to reward their shareholders and attract new investors.

Companies with a history of paying consistent and increasing dividends may be viewed as more stable and reliable, which can attract investors who prioritize income generation over capital appreciation.

Buyback

A buyback is when a company buys back its own shares from the market. This can reduce the number of shares outstanding, increase earnings per share, and boost the stock price.

For example, let’s say a company XYZ Ltd announces a buyback of up to 1 million shares at a price of Rs. 1,200 per share. Suppose the current market price of XYZ Ltd’s shares is Rs. 1,000 per share. The company intends to use its available cash to repurchase its own shares in order to reduce the number of outstanding shares.

If an investor owns 100 shares of XYZ Ltd and decides to tender their shares, they will sell their shares back to the company at the buyback price of Rs. 1,200 per share. The investor will receive Rs. 1,20,000 (i.e., 100 shares x Rs. 1,200 per share) for their shares.

Suppose the company successfully buys back 1 million shares through the buyback program. After the buyback, the total number of shares outstanding will be reduced, which can increase the earnings per share and potentially increase the market price of the remaining shares.

Buybacks are often used by companies to signal to the market that they believe their shares are undervalued and to return cash to shareholders.

Buybacks can also be used to improve financial ratios such as earnings per share, return on equity, and price-to-earnings ratios.

By reducing the number of outstanding shares, buybacks can also increase the control of existing shareholders over the company.

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