In the world of business and finance, corporate actions govern a company’s future, for better or worse. A good understanding of the corporate action life cycle can give you a clear idea of the company’s ethical business conduct and financial health.
In this blog, we learn about corporate action processing, and how it affects stock prices. What happens when bonus shares are issued?
A corporate action is an initiative taken up by the Board of Directors with the approval of the shareholders of a company. It includes a critical juncture that brings about a substantial change to the company and its stock prices. Now, this could be something as minor as changing the name of the company to something as crucial as declaring dividends.
From a financial perspective, corporate actions can be classified into two broad categories, namely, monetary and non-monetary. In other words, while some corporate actions have a financial impact on the company and its shareholders, others don’t.
For instance, changing the name of the company is a non-monetary corporate action. Whereas deciding to declare a dividend is a monetary corporate action that will ultimately affect the stock prices.
Let us learn the five most important corporate actions involving financial impact in detail in the next section.
Dividends are what a company pays to its shareholders out of its profits and reserves as a form of regular income. Typically, it is paid on a per-share basis or as a percentage of the face value of the share.
Let’s understand this with a real-life example:
Example: Majesco had declared an interim dividend of Rs 974 per share. At the time the dividend was declared, which was the last few days of December 2020, the stock was trading at Rs 980+ per share level. The price of one share will drop after deducting the dividend amount. From Rs 985.65 per share on December 21, the price dropped to Rs 12.2 per share on December 22, 2020.
Bonus shares are additional shares issued to the shareholders by the company. For instance, a 1:1 bonus issue means for every share you hold; you get an additional share in the company.
So, what happens to the share price after bonus issue? The total share value does not decrease or increase as the value per share gets adjusted proportionately.
If you hold 50 shares of Rs 10 each, after a 1:1 bonus issue, your holdings become 100 shares of Rs 5 each. The total share value of Rs 500 does not change, yet there is a decline in the value per share, making it easier for small investors to invest.
Example: Astral Poly Technik is a plastic pipes company. It had announced a 1:3 bonus issue and fixed March 19, 2021, as the record date. According to this, 1 equity share of Re 1 each will be given for every 3 existing equity shares of Re 1 each.
As the name suggests, a stock split splits the stock into two or more portions. They work on the same principle as bonus issues. The number of shares with the shareholders increases after a stock split, but the investment value remains the same.
Suppose a company declares a 1:2 stock split. The face value of the stock you hold is Rs.10. If before the split you held 25 shares, after the split, you will hold 50 shares. The face value will change to Rs.5 per share, keeping the total investment value of Rs.250 intact.
Generally, stock splits happen when a company’s share prices are quite high, and the company wants to bring them down to encourage more investors. It increases liquidity in the company.
Example: An example of a recent stock split in India is Eicher Motors. The company, which was one of the most expensive stocks in India in terms of per-share value until August 2020, announced a stock split of 1:10 effective August 24, 2020.
The company’s shares started trading at Rs 2,300 per share levels after the stock split as compared to levels of Rs 21,700 per share levels right before the stock split.
You may also want to read Difference Between Bonus Issue and Stock Split
A rights issue is when a company issues additional shares to its existing shareholders instead of the public at large. Unlike bonus shares, you need to actually pay money to buy these shares, usually at a discounted price. For example, a 1:5 rights issue means for every 5 shares you hold, you can subscribe to 1 additional share.
A company may go in for a rights issue to finance its expansion or for debt reduction. Hence, it is pivotal that you subscribe to these shares only if you are confident about the company’s future.
Example: Reliance Industries had announced a rights issue in April 2020 in the ratio of 1:15: which meant that you would get 1 share for every 15 shares of RIL you held. It was offered at Rs 1,257 per share, which was a 14% discount from the closing price on April 30, 2020.
A buyback of shares is when a company buys its shares from its shareholders to consolidate its stake in the enterprise. Usually, the shares are bought at a premium to reduce the number of outstanding shares in the market. This increases earnings per share. A buyback is seen as a positive sign reflecting the company’s confidence in itself. Some other reasons for buyback include:
Example: GAIL announced a buyback of around 6.97 crore shares on February 25, 2021, at Rs 150 per share. The record date was set on January 28, 2021. GAIL paid for the share buyback from the internal cash resources of the company.
It is pivotal to understand the effects of corporate actions and what happens when bonus shares are issued to evaluate a company’s worth. A rights issue may drive the share prices down with an increase in the number of shares in the market.
Whereas a buyback may create a sudden temporary spike in the share prices as there is a reduction in the availability of the outstanding shares in the market. Understanding these corporate actions can help you decide whether you wish to buy or sell your shares.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.