As investors, we have witnessed several corporate events that have either a direct or indirect impact on the company’s share price. Therefore, it is essential for every investor to have a thorough understanding of these corporate actions to gain an advantage in investing.
What are Corporate Actions?
These corporate events are also known as “corporate actions,” which refer to specific actions that have the potential to significantly change the company’s share price. They are usually activated by a board resolution passed by the company.
There are six important corporate actions that we are going to discuss in this article:
- Bonus Issue
- Stock Split
- Rights Issue
- Buyback of Shares
- Mergers and Acquisitions
Types of Corporate Actions and their Impact on Share Price
A dividend declaration demonstrates the company’s stable financial condition. The fact that the company pays a dividend from its surplus profits indicates that the company’s financial position and profitability are strong. Here is the list of upcoming dividend paying stocks.
When a company declares a dividend, the share price of that company may temporarily increase in value. Because it fosters a positive perception of the company in the minds of investors, it ultimately generates demand for the stock among investors.
2. Bonus Issue
Bonus shares are free additional shares distributed to the company’s existing shareholders. A “stock dividend” is another term for it. It is issued when a company does not have enough cash reserves to pay a dividend to its shareholders. As a result, the company offers free additional shares to its shareholders to boost their morale. They are issued in a specific ratio, such as 4:1, which means that for every four shares owned, a shareholder is entitled to one additional or bonus share. The company’s valuation remains constant; only the share price decreases in proportion to the number of outstanding shares.
Bonus issues generally lower share prices, which eventually increases retail participation in the specific share. As a result, the number of outstanding shares rises while the share price falls.
3. Stock Split
It is essentially a corporate action in which each of the company’s existing shares is divided into multiple numbers of shares. This generally results in a decrease in share price and a proportionate increase in the number of shares.
There are two types of stock splits, and both work contradictory to each other.
a. Forward Stock Split: This divides existing shares into multiple numbers of shares as per the ratio.
b. Backward Stock Split: This is the measure undertaken by the company to reduce its outstanding shares.
Stock splits are carried out to increase market liquidity. For example, if the company announces a stock split of 3:1, shareholders who initially held 100 shares will be converted into 300 shares.
Difference between Bonus issue and Stock Split.
Bonus issue: Face value remains the same, and new shares are allotted by the company.
Stock Split: Face value changes, and no new shares are allotted by the company.
4. Rights Issue
It is the tool that the company uses to raise new capital. Existing shareholders are the ones who are initially offered to subscribe to the right issue at a price lower than the current market price or at a discounted price. For example, if the company’s shares are trading at Rs 100, the shares will be offered to existing shareholders at a lower price, such as Rs 90 or 80.
If all of the shares issued under the right issue are subscribed to by existing shareholders, it demonstrates the company’s shareholders’ confidence in the company’s growth. This action has a positive effect on the share price of the specific stock.
5. Buyback of Shares
When a corporation purchases its own stock from its shareholders to reduce the number of outstanding shares or increase its stake in the company, it is known as a buyback of shares.
Buying back its own shares is usually viewed as a positive sign for a company, indicating that it is stable and gaining strength. This can lead to a temporary rise in the share price of the company.
6. Mergers and Acquisitions
Before we discuss the impact of mergers and acquisitions, it’s important to understand the difference between the two terms.
Mergers: A merger is a combination of two companies into a single entity.
Acquisitions: An acquisition occurs when one company purchases over 50% of the shares of another company to establish control.
Examples: Vodafone-Idea merger and Flipkart’s acquisition by Walmart.
Also Check: Biggest Mergers and Acquisitions in India
Mergers and acquisitions typically cause volatility in the stock prices of both companies involved in the transaction. The news of mergers and acquisitions is heavily publicized, which creates two camps: pessimistic investors who criticize the deal for various reasons, such as overvaluation of the target company, and optimistic investors who see the transaction as an opportunity to buy stock.
For example, in the Walmart-Flipkart acquisition deal, in which Walmart acquired Flipkart by purchasing 77% of its stake for 16 billion dollars, pessimistic investors largely criticized the deal due to the target company’s overpricing. Despite Amazon being the largest e-commerce giant, they believed that Flipkart’s pricing was excessive. The impact of this pessimistic attitude was seen in Walmart’s share price, which fell by 4.2% on the New York Stock Exchange in the aftermath of the transaction.
Analyzing corporate actions enables market participants to efficiently judge the price movement of the stock market. Furthermore, a thorough understanding of corporate action enables an individual to take effective stock market positions. However, because most corporate actions have short-term consequences, investors should exercise caution when investing in any particular stock.