Top 5 Impact of Coporate Actions on Stock Prices | Espresso

Top 5 Corporate Actions and Their Impact on Stock Price

Stock prices are extremely sensitive things. There is a war, prices change. There is a pandemic, prices fluctuate. A company takes some crucial corporate actions, and prices are affected. Therefore, it is essential to understand how external stimuli can impact stock prices as an investor. This can help you make better decisions in a timely manner.

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In this article, we will discuss the corporate action meaning and how it can alter the price of a company's stock. 

What are Corporate Actions?

Corporate actions are decisions that a company takes that can directly or indirectly impact its stock prices. These actions are taken by a public limited company's board of directors and require the shareholders' consent and approval. Corporate actions can impact the financial securities of a company, such as equity and debt issued, which is why they are critical for stock investors. 

Corporate actions can include a number of things, such as declaring bankruptcy or simply making some changes in the board of the company. Based on their nature, they can be categorised as monetary and non-monetary. The former has a direct financial impact on investors, and the latter does not. 

Five Corporate Actions and its Impact On Stock Prices

Here are five corporate activities and their effect on stock prices:

  • Announcing dividends

Announcing a dividend can change a company's stock price. Dividends are paid to shareholders when a company makes a profit and decides to share the same with its shareholders. Not all companies pay dividends. Additionally, if a company pays a dividend the first year, it may not do so the following year. Sometimes companies like to use their profits for further expansion and future projects. Sometimes, companies also pay dividends from their cash reserves even if they have made a loss. 

Dividends are announced for each share of a company. For instance, if you own ten shares for ₹10 each and the company announces a dividend of 100% per share, you will receive ₹10 x 10 = ₹100 as the total dividend.

When a company announces a dividend, the stock price generally falls by the amount of the dividend. For instance, if the stock price is ₹300 and the company announces a dividend of ₹10, the stock price may drop to ₹290. 

  • Bonus issue

In simple words, a bonus issue refers to additional shares that a company offers its shareholders as a reward. It is announced as a ratio. So, companies can declare bonus issues of 1:1, 1:2, 3:2, and more. This implies that if you receive a bonus issue of 1:1, you will receive a share for every share you own. Likewise, if you receive a bonus issue of 1:2, you will receive two shares for every share you own. However, the bonus issue changes the stock price. Here's how this happens. 

If you own ten shares for ₹10 each, your total investment value is ₹100. The bonus issue does not alter the total investment value but the per-share cost. So, if you get ten additional shares in a 1:1 ratio, the price per share will drop to ₹5. This way, your total investment value will still remain ₹100 (5 X 20). 

  • Stock split

Corporate actions like a stock split tend to divide a stock, so your overall share is increased. Stock splits are also announced in ratios like a bonus issue. Moreover, the total investment is unchanged. So, if you own ten stocks of ₹10 each, after a stock split of 1:2, you will have 20 stocks of ₹50 each. The total value will remain constant at ₹100, but you will own more stocks. Companies announce stock splits when their share prices increase, and they want to encourage new investors by lowering the cost. 

  • Rights issue

A rights issue is a reward for the existing shareholders. When a company announces a rights issue, it offers additional shares to its current shareholders, excluding the general public. However, while this may sound similar to a bonus issue, there is one significant difference.

In a rights issue, shareholders have to pay to buy the additional shares. But they stand to benefit nevertheless as the stock price of the new shares is lower than the market price. When companies need more capital to meet their needs and fund expansion, they often take this route. Rights issues are also announced as ratios.

So, if you get a rights issue of 1:3, you can buy one more share for every three shares you own. The critical thing to note here is that you are not obligated to buy the new shares. You can do so only if you see merit in the investment and the stock price is lower than the open market. 

  • Buyback of shares

Buyback of shares refers to when companies repurchase their shares from the shareholders. Since the number of outstanding shares decreases in the market when this happens, the stock prices increase. Companies opt for this route when they want to improve their control of the company and higher their stakes in the enterprise. 

Conclusion

Now that you know these five corporate actions and their impact on stock prices make sure to keep an eye on them. Being up to date and tracking these announcements can help you maximise your returns and tap on market opportunities. 

 

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Frequently Asked Questions

Corporate actions can either increase or decrease the stock price. 

There are two types of corporate actions:

  • Monetary 
  • Non-monetary

Companies take corporate actions for a number of reasons, both financial and non-financial. 

The company itself will inform you through email. You can also keep track of corporate actions on the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) official websites.