InvestorQ : What exactly are corporate actions and how do they impact ?
Lavanya Subramanian made post

What exactly are corporate actions and how do they impact ?

3 years ago

Corporate actions include involuntary non-cash actions like bonus and splits; involuntary cash actions like dividends; voluntary cash actions like rights issues and voluntary non-cash actions like mergers and amalgamations. Let us look at some of the key corporate actions.

Dividends:They are profits distributed among shareholders. Normally, the dividends tend to impact the price of the stock negatively. Technically, a payout of Rs.5 as dividend will depress the stock price by Rs.5. When index components pay out dividends, the index also gets adjusted downward automatically.

Bonus Issues:A bonus is paid out of the free reserves of the company and is a free share issued by a company at zero cost. A 1:1 bonus means that you get 1 free share for each share held. A 1:1 bonus will lead to doubling of the number of shares outstanding and therefore the price will halve. The impact of a bonus on the stock price is inversely proportion to the bonus ratio. A bonus is normally given to bring the stock price into a more attractive range, although there is no wealth effect of a bonus issue.

Stock splits:A stock split is a change in the par value of the stock. If you are holding 1000 shares of par value Rs. 10. If the company now split the par value from Rs.10 to Rs.2, then you will end up holding 5000 shares of par value 2. The price impact of a stock split is the same as in case of a bonus. Like a bonus, a split is also used to bring the stock price into a more popular trading range, especially in case of high priced stocks.

Rights:These are preferential allotment given to the existing shareholders in a pre-determined ratio at a discounted price. Unlike bonus and splits, rights actually result in fresh funds raised by the company. However, as the earnings get distributed across more number of shares, the price goes down. But since rights are issued at a discount to shareholders, they tend to be value accretive for them.

Buybacks:Normally, buybacks are undertaken by companies which are sitting on large profits but do not have too many investment opportunities. Therefore they choose to return funds to shareholders via buybacks. A buyback is a more tax-efficient way of rewarding shareholders compared to dividends. A buyback tends to reduce the number of shares outstanding and hence pulls up the EPS. However, in the long run buybacks are seen as a signal of limited future growth prospects and hence the P/E is downgraded. As a result, the net impact of a buyback on the company valuation is normally negligible.

Mergers and Swaps:These are cases where the existing company merges with another company or gets taken over. In such cases the shareholders of the merging company get shares in the acquiring company. The impact on the stock prices will largely depend on the merger ratio and the presumed benefits of the merger to both the companies involved.