The Basics Of Stock Market

Lesson -> Five Corporate Action and its Impact on the Prices Of Shares

11.1 - Overview

Corporate actions are any initiative taken by a corporate entity to bring about a change in its stock. An entity can choose from many different types of corporate actions. Understanding these corporate actions will give you a better understanding of your company's financial health. This will help you decide whether to purchase or sell a stock.

This chapter will focus on the five most important corporate actions and their effect on stock prices.

The board of directors initiates a corporate action and it is then approved by shareholders.

11.2 - Dividends

Dividends are paid to shareholders by the company. Dividends are used to distribute profits earned by the company over the past year. Dividends are paid per share. In 2012-13, Infosys declared a dividend at Rs.42 per share. Also, the dividend paid is expressed as a percentage from the face value. The above example shows that Infosys' face value was Rs.5/– and the dividend was Rs.42/–, so the dividend payout is 840% (42/5).

Dividends do not have to be paid each year. If the company believes that it is better to pay dividends to shareholders than to use the cash to fund a project for a better tomorrow, they can.

The dividends can be paid out of the profits as well. The company can still pay dividends if it has suffered a loss in the past year but has a healthy cash reserve.

Sometimes, the best thing for a company is to distribute dividends. If the company has exhausted its growth potential and is in excess of cash, it might make sense to pay dividends to shareholders. This would repay the trust that shareholders have in the company.

The Annual General Meeting (AGM), during which directors meet, decides whether to pay a dividend. The announcement does not mean that the dividends will be paid immediately. Because the shares are traded throughout the year, it is difficult to determine who receives the dividend. This timeline will help you understand the dividend cycle.

Dividend Declaration Day: This date is when the AGM takes place and the board approves the dividend issuance

Record Date When the company reviews the shareholders register and lists down all eligible shareholders to receive the dividend. The time difference between the record date and dividend declaration date is usually 30 days.

Ex-Date/Ex-Dividend date: The ex-dividend dates are normally set two days prior to the record date. This is why the dividend cannot be received.. For all practical purposes, it is important that you purchase the shares prior to the ex-dividend date if you wish to be eligible for a dividend.

Dividend Payment Date: When dividends are paid to shareholders who are listed in the company's register.

Cum Dividend: The shares will be considered cum dividend until the ex-dividend day.

Stocks that are ex-dividend usually drop to the amount of dividends received. If ITC (trading at Rs. 335 has declared an Rs.5 dividend. Ex-date will see a drop in stock prices to the amount of the dividend paid. As such, the ITC price will fall to Rs.330. This is because the company has not received the dividend.

Dividends may be paid at any time during the financial year. It's called an interim dividend if it's paid within the financial year. The final dividend is when the dividend is paid at end of the financial year.

11.3 -  Bonus Issue

A bonus issue is a stock dividend that a company gives to its shareholders as remuneration. These bonus shares are drawn from the company's reserves. These shares are free and can be exchanged for shares they already own. These are usually in fixed proportions such as 1:12, 2:1, 3:1, etc.

If the ratio is 2:1, existing shareholders will receive 2 shares for every 1 share. If a shareholder holds 100 shares, 200 additional shares will be issued to him, making his total holding 300 shares. The number of shares a shareholder has will increase when bonus shares are issued. However, an investment's total value will not change.

Let's take as an example, a bonus issue based on three different ratios: 1:1, 3:1, and 5:1.

There will be a bonus announcement date and an ex-bonus date. The record date will be similar to the dividend issue.

Bonus shares are issued by companies to encourage retail participation. This is especially true when the price per share of the company is high and it is difficult for new investors to purchase shares. As shown in the above example, bonus shares increase the number of shares outstanding, but the value of each share decreases. The face value of each share remains the same.

11.4 - The Stock split

Although stock splits sound strange at first, they are a common occurrence in the markets. This means that the stocks you own are actually split.

The stock split is when the company issues more shares, but the investment value/market capitation remains the same as the bonus issue. The stock is divided according to its face value. Let's say the stock has a face value of Rs.10. If there is a 1:1 stock split, the face value will be Rs.5. You would now have 2 shares if you own 1 share of the stock before the split.

This is an example of how it works:


A stock split, which is similar to a bonus issue in that it reduces the share price per share, is often used to encourage retail participation.

11.5 - Rights Issue

capital can be raised by Right Issue. Instead of going public, however, the company approaches existing shareholders. Think of the rights issue as a second IPO, and a small group of people (existing shareholders). The rights issue could indicate promising development within the company. Shareholders can subscribe to the rights in proportion to their shareholding. One:4 rights issue is an example of how every four shares a shareholder has can be subscribed to one additional share. The new shares issued under rights issues will, naturally, be at a lower cost than the market.

A word of caution: Investors should not be seduced by the company discount. They should think beyond that. Rights issues are different than bonus issues in that one is actually paying money to acquire shares. The shareholder should only subscribe if they are confident about the company's future. It is cheaper to purchase it on the open market if the market price is lower than the subscription price/right price.

11.6 - Buybacks of shares

Buybacks are a way for a company to buy shares from other investors on the market. Although buybacks decrease the number of shares in the market, they are an important method of corporate restructuring. Corporates may choose to purchase back shares for many reasons.

  1. Increase profitability per share
  2. To consolidate their share in the company.
  3. To stop other companies from taking over.
  4. To demonstrate the confidence of promoters in their company.
  5. To prevent the market's decline of the share price.

A buyback is a signal of confidence in a company. This is often a positive sign for the share price.

To Summerize

  1. Stock prices are affected by corporate actions.
  2. Dividends can be used to reward shareholders. Dividends are calculated as a percentage from the face value.
  3. You must own the stock prior to the ex-dividend date if you want to receive the dividend.
  4. Bonus issues are a type of stock dividend. This is the company’s way to reward shareholders with additional shares.
  5. Stock splits are based on face value. As the face value changes, so do the stock price.
  6. Rights issues are a way for a company to raise capital from existing shareholders. It is only recommended that you subscribe if it makes sense.
  7. Promoters who buy back signal a positive outlook. This signalizes to shareholders that promoters are positive about the company's future prospects.