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Do you invest in a hunch? Or do you conduct a quick background check before investing in the stock? If the latter is your go-to, you deserve a standing ovation. Believe it or not, many new investors just follow the herd while investing. But you must take a deep dive if you wish to make a career out of investing or trading. How? Two words – corporate actions!
What are corporate actions?
Put simply, corporate actions are the decisions and actions taken by a company’s board of directors and invariably affect the shareholders of the company. These actions can range from issuing new shares or repurchasing them to paying out dividends, splitting the stock…the list goes on.
Picture a company as a ship sailing on the stock market seas. The captain of this ship charts the future course of their journey. The captain’s route is similar to the decision of a company’s board of directors.
(Instead of water, the ship will be sailing on the sea of stocks)
A ship’s voyage can be affected by rough waters and strong winds. Similarly, corporate actions can have a big impact on the financials of the company. As an investor, you need to follow these financials. As they will ultimately drive the company’s share price.
Impact on Shareholders
Any corporate action, be it positive news of business expansion or an unfavourable decision of layoffs, can impact shareholders. These include both internal and external shareholders. You become an external investor if you invest in a company through a stock exchange.
Now that this is clear, let’s take the example of a layoff at Zomato –
In 2022, reports were floating around about Zomato laying off 13 per cent of its workforce. Why? The reason is quite apparent – to cut costs amid inflation. Layoffs are a corporate action which can impact a company’s image among investors.
Around that time, a BusinessToday report stated that Zomato shares plunged 4 per cent on the Bombay Stock Exchange. Why? Apparently, the layoff news impacted investor sentiment. Thus, many investors decided to sell off their holdings in Zomato.
This is just one example of corporate actions impacting shareholders. But, as a stock market observer, these corporate actions can help you predict how a stock may perform.
What is the dividend of the stock market?
A dividend is a portion of a company’s profits paid to its shareholders. For example, let’s say that you own 100 shares of Tata Motors stock, and the company decides to pay a dividend of Rs.100 per share.
This means that you’ll receive a payout of Rs.10,000. This can be a great way to earn passive income from your investments.
Here’s something interesting: Dividend Aristocrats, Dividend Kings
Have you heard of ‘Dividend Aristocrats’? They are the companies that have consistently increased their dividends for 25 years or more. By similar logic, ‘Dividend Kings’ are the ones who have increased their dividends for 50 years or more. These companies are considered reliable sources of income for investors. It’s no surprise that their shares sell like hotcakes among retirees and those seeking a steady income from investments.
What is a rights issue in the stock market?
A rights issue is a type of corporate action where a company gives its existing shareholders the right to buy additional shares at a discounted price. Think of it as a way for the company to raise capital while giving its current shareholders the first chance to invest.
Generally, offering a rights issue is a faster way to raise capital compared to a follow-up price offer. Why? Because a rights issue is directed at shareholders, while FPO is directed at investors in general. The chances of investing are higher among shareholders compared to investors.
For example, let’s say that you own 100 shares of XYZ Company, and the company decides to issue a rights issue of 1 new share for every 2 shares you already own. This means that you would be entitled to receive 50 new shares. Along with increased stakes in the company, you also get a discounted price to purchase them. Sounds like a win-win situation for both – shareholders and the company.
Rights issue vs dividend vs stock bonus
A rights issue allows you to purchase more shares in the company. However, a dividend is a payout of the company’s profits. A stock bonus is when a company issues new shares to its shareholders for free. It’s essential to understand the differences between these actions, as each brings a different type of value to the table.
Confused? Let’s put things into perspective. Consider the three corporate actions as revenue streams., from the same company. Assume you’re a shareholder in the firm. Under a rights issue, you can purchase additional shares at a discounted rate in a specific ratio. Thus, your stake in the company increases.
In the case of a dividend, the company pays you a chunk of its profits. So, you end up earning some money without any change in your stakes. Finally, in the case of a stock bonus, the company offers you a share free of cost. Again, in a specific ratio. Mostly, the ratio in stock bonuses is smaller than the rights issue.
While dividends offer a steady income, stock bonuses or rights issues offer higher stakes in the company. And if the stock price booms, you will reap higher profits.
What is a stock bonus issue?
A stock bonus issue is when a company issues new shares to its existing shareholders for free. For example, let’s say that you own 100 shares of ABC Company, and the company decides to issue a stock bonus of 1 new share for every 5 shares you already own. This means you would receive 20 new shares at no cost.
What is a stock split in the share market?
A stock split is when a company decides to increase the number of outstanding shares by issuing more. For example, let’s say that you own 100 shares of DEF Company, and the company decides to do a 2-for-1 stock split. This means you would own 200 shares, but each share would be worth half as much as before.
Stock split vs stock bonus
A stock split increases the number of shares outstanding, while a stock bonus issues new shares to shareholders for free.
What is a stock buyback?
A stock buyback is when a company buys back its own shares from the market. This can increase the value of the remaining shares as it reduces the number of outstanding shares.
FAQs
Various parties are involved in fulfilling corporate actions. While the company’s management decides the corporate action, the legal department ensures compliance with necessary regulations. Transfer agents and custodians work on transferring securities between the company and investors. Some corporate actions involve investment banks for advisory services.
The corporate action life cycle encompasses all activities related to the corporate action. It starts with the company’s management deciding on the strategy and making an official announcement about it. The cycle is complete when shares are credited to relevant accounts, and the shareholding pattern is revised.
The record date is the key to deciding eligible investors for corporate actions. Companies announce a record date, on which they conduct an audit to check the list of active shareholders. So, all active shareholders on the record date will be eligible for the benefits of a corporate action.
Any activity that results in material impact and changes the shareholding pattern of the organisation comes under corporate actions. So, an IPO is also a corporate action as it brings in additional capital and new shareholders to the company, which finally impacts the company’s financial statements.
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