Chapter 6: Corporate Actions

Chapter 6: Corporate Actions

 

Any action taken by the company that creates an impact on issued securities is known as corporate action. Dividend, stock split, bonus and rights issue are examples of corporate action.

Typically, corporate actions are approved by the company’s shareholders and Board of Directors.

6.1 Dividend

A dividend is a part of the profit distributed by the company to its shareholders. Distribution percentage (dividend payout ratio) is decided by the company management depending on capital requirement, cost and availability of alternative funds, liquidity, etc.

For example, if a company with 10 crore outstanding shares has a net profit of Rs. 50 crore and decides to distribute 40% of its profits to shareholders, then per share dividend will be Rs. 50,00,00,000* 40%/10,00,00,000 = Rs. 2

A dividend is paid on the face value of the share and sometimes declared in percentage form. If a company share price is Rs. 500, face value of the share is Rs. 2 and the company declares a dividend of 250%, then its shareholders will receive a dividend of Rs. 2*250% = Rs. 5 per share. Typically, a company declares dividend at the end of the financial year, but sometimes, it may declare dividend during the financial year, which is also known as interim dividend.

 

Dividend yield

Dividend yield can be calculated by dividing the dividend amount by the market price of the share.

Dividend yield = Dividend amount / Market price

For example, if a company declares a dividend of Rs. 2 per share and its share price is Rs. 500, its dividend yield would be 2/500 = 0.4%

Some stocks have a dividend yield in the range of 5-6%. These stocks are preferred by conservative investors due to lucrative dividend yields and opportunity of capital gain.

Typically, people invest in the equity market for capital gains, but sometimes an attractive dividend could also be the reason for investment. It is better to focus on total returns on the stock that includes capital appreciation and annual dividends.

 

6.2 Stock split

A stock split is division of the stock’s face value into small parts to enhance the liquidity of the stock in the market by making it affordable to investors. Typically, it is done for those stocks where the market price of a share becomes too high resulting in an impact on the liquidity of the stock. It is like splitting one currency note of Rs. 2,000 into 10 notes of Rs. 200 each. This will enhance liquidity but will not have any impact on the economy or the individual’s wealth.

For example, a stock with a face value of Rs. 10 currently trades at Rs. 5000 per share. If a company decides to split the stock in 5 parts for every 1 share, then after the split, the number of shares will be multiplied by 5, the face value of the stock will be reduced to Rs. 2 and the market price will be reduced to approximately Rs. 1000 per share. There will not be any impact on shareholders’ wealth, market capitalization, etc. except that the number of shares in the market will have increased.

There is no direct benefit to shareholders post stock split. The impact is mainly on liquidity which increases since the stock is now more affordable to small investors.

 

6.3 Bonus issue

In the case of a bonus issue, shareholders receive additional shares from the company in a ratio decided by the company without them having to pay any additional money. This is one of the ways of rewarding existing shareholders. Post bonus, the stock price will reduce on a proportionate basis while the face value remains unchanged.

For example, you own 1 share of a company, ABC Ltd., whose share is currently priced at Rs. 500 per share. If ABC Ltd. announces a bonus in the ratio of 1:1, it means you will receive 1 additional share without paying anything. Post bonus, you will have 2 shares, but the share price will be reduced to half i.e. Rs. 250. It means that your net worth remains the same post bonus issue.  So a bonus issue does not have any immediate benefit to shareholders. But in the longer term, it will be beneficial to investors as they hold more number of shares, and if the company performs better, share prices will rise and lead to higher capital gains for investors.

To be eligible for bonus shares, you should own the share on the record date specified by the company.

How is bonus share beneficial to investors?

There will not be any immediate benefit to shareholders in case of a bonus but in the longer term, it will be beneficial to shareholders as they own more number of shares and it results in a multiplier effect when the price of the share increases. Due to a bonus issue, the share price reduces and becomes more affordable to investors, which in turn increases the liquidity of stocks and investors can sell the share even for a small amount as per their requirement.

 

6.4 Rights issue

Rights issue is a method used by listed companies to raise additional capital by issuing fresh shares to existing shareholders. The company offers the right at a discount on a pre-decided ratio to existing shareholders. If an investor does not want to use their right, they can sell it to others in the market.

For example, if a company’s current share price is Rs. 100 and it decides to go for a rights issue in the ratio of 2:5 at the price of Rs. 85, it means that existing shareholders can purchase 2 additional shares at the price of Rs. 85 for every 5 shares they hold.
 

Post the issue, ex right price can be calculated as following:
Cost of initial 5 shares @ Rs. 100 per share = 500
Cost of additional 2 shares@ Rs. 85 = 170
Ex Right price = (500+170) / (5+2) = 95.71

 

How is the rights issue beneficial to an investor?

Rights issue gives an opportunity to shareholders to increase their stake in the company at a discounted price. But investors should be cautious about fall in price post closing of the rights issue. They should calculate the ‘ex right price’ and make a decision on the prospects of the company at the current valuation.

 

6.5 Book closure and record dates

Book closure is the period in which a company does not accept requests to transfer shares. This is used to determine the cut-off date also known as the record date. The record date is a date announced by the company for deciding the eligibility of shareholders for any corporate action, i.e. dividend, split, bonus share, etc. If an investor holds the share on the record date, only then are they eligible to receive the benefit of corporate action. To define cut-off eligibility criteria, an ex-date is fixed, that is typically one day before the record date.   If an investor purchases the share before the ex-date, they are eligible for the announced benefit.

For example, if the record date for dividends is June 10, then the ex-date would be June 9. If an investor purchases the share before June 9, then they will be eligible for corporate benefit. In this case, till June 8, shares will be in a cum dividend mode.