How do Corporate Actions Impact the Stock Price?
When a company is run by an individual or a group of individuals, it is known as a proprietorship or partnership company. All decisions related to the company are taken by its proprietors or business partners. However, when a company sells its stake by getting listed on the stock exchange(s), it becomes a corporation or a corporate company.
It’s because the company gets incorporated by a group of shareholders who share ownership rights in it. Any initiatives or actions taken by these corporate companies significantly impact their share prices. In this blog, you will learn about different types of NSE or BSE corporate actions and how they impact stock prices. However, first, let’s discuss what corporate actions are.
What are Corporate Actions?
A corporate action is one that a company takes that has a direct impact on shareholder value. In other words, it is an event that brings about a material change to the company and impacts its stakeholders. It could be monetary, e.g. dividends, or it could be non-monetary, e.g. bonuses, stock splits, or rights.
While some corporate actions have a negligible impact on stock prices, the other major ones can bring about a substantial movement.
Let’s discuss five crucial corporate actions and their impact on stock prices:
When a company makes substantial profits, it distributes them among its shareholders in the form of dividends. Dividends are typically paid to shareholders as a fixed amount on a per-share basis. For example, if a company decides to pay Rs 2 per share as a dividend, an investor holding 1000 shares would become eligible to receive Rs 2000 from the company.
The declaration of dividends is usually followed by a temporary rise in the company’s share prices because everyone wants to buy them to receive the profits. However, after the initial euphoria, the share’s prices may go down again.
Another way by which corporates distribute their profits among the shareholders is by issuing bonus shares. Sometimes, a company also issues bonus shares to encourage more retail participation by investors. Bonus shares are issues in a particular ratio. For example, a 2:1 bonus share issue means that an investor gets two shares as a bonus for each share they own.
When a company issues bonus shares, the prices of its shares fall in an equal proportion to keep the valuation of the company the same. Therefore, the number of outstanding shares of a company increases after the issue of bonus shares, but the price of each share reduces.
When a company decides to split its existing share, it is known as stock split. Usually, corporates split their stocks to make them more liquid and affordable for retail investors.
As a result of a stock split, the number of shares increases while the price of each share decreases proportionally. Despite this, the market capitalization of the company remains unchanged. For example, if a company declares a 2:1 stock split, an investor holding 100 shares of the company before the split will now own 200 shares. However, the price of each of their share will be halved.
Sometimes, companies decide to offer an option to their existing shareholders to purchase additional shares at a discounted price. Such an offer is known as the rights issue. Unlike the issue of bonus shares, shareholders are required to pay an amount to the company to receive additional shares. A company usually opts for the rights issue to finance its expansion or reduce its debts.
Generally, the incidents of rights issues are followed by a temporary bounce in the stock prices since they indicate the future growth of the company. However, this rise in stock prices can be for a short duration only.
Buyback of Shares
A company may also decide to buy back its shares from the shareholders. This is usually done to consolidate its stake by reducing the number of shareholders. The buyback of shares is usually seen as a positive sign since it indicates that the company is gaining strength. That is why such incidents result in a temporary or permanent increase in stock prices.
A deep understanding of the corporate actions mentioned above and how they impact stock prices can help you take active positions in the stock market. As a trader, you can benefit from price movements. However, as an investor, you should always look at the larger picture and ignore any short-term implications.
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