Corporate Actions and their impact on stock prices

Shareholders are the true owners of the company but they are not responsible for its day-to-day affairs. This is the job of the company management and they are responsible to achieve the company’s objectives. Their decisions impact the company’s future and ultimately the stock prices. These corporate actions have a lasting impact and shape the future or the direction of the company in the long run. Therefore, it is prudent for investors to understand these corporate actions and their impact on the company’s stock prices. Given below are the details of the same. 

Read More: How are stock prices determined? 

What are corporate actions?

Let us begin with the meaning of the term ‘Corporate actions’. Corporate actions are any decisions taken by the management of the company or the Board of Directors that have a material impact on the company. These material decisions can be small or major depending on their ultimate impact on the future of the company. Some examples of corporate actions can be any change in the company policy or product line, merger with another company, reconstruction of the company debt or equity, etc. These actions have a lasting impact on the company and have mandatory or voluntary implications on the shareholders depending on the nature of the action. 

It is important to keep track of the corporate actions for shareholders as well as potential investors as they reflect the financial health of the company and its position in the industry. Some corporate actions can be proactive in line with the company vision or a response to the macro or microeconomic conditions that affect the company. Therefore understanding corporate actions can help investors under the strategies of the company for its ultimate survival and growth. 

How can corporate actions impact stock prices?

Some corporate actions have an immediate impact on stock prices as they trigger a change in the perception of investors or market sentiment toward the company’s shares. Some of such major corporate actions that can have a defining impact on stock prices are discussed hereunder. 

1. Dividends

Dividends are the distribution of company profits to its shareholders. It is a routine business exercise but has an immediate impact on the share prices. When a company decides to declare dividends, it has to follow due process as per the provisions of the Companies Act, 2013, and pass a resolution for the same. 

The next step is to declare the same to the shareholders through a notice and to notify the stock exchanges as well. This triggers a demand for the stock and it commands a higher price till the ex-dividend date (the cut-off date for the name of eligible shareholders to be included in the company records). Post the record date, the demand for the shares goes back to levels before declaring dividends, and thus the prices more or less stabilize. 

2. Stock split

Stock splits are major corporate actions taken by the management of a company that has a direct impact on its stock prices in the market. A company announces stock splits usually if its shares are priced quite steeply and it aims to make its shares more affordable ultimately attracting more retail investors. The company announces the ratio in which the shares will be split and the market reacts by a reduction in the share prices to their original levels.

 For example, if shares of Company A are traded at Rs.100 and the company announces a stock split in the ratio of 1:10, the value of the shares would typically reduce to approximately Rs.10. The number of shares held by a shareholder will increase as per the stock split ratio but the market price per share will reduce. 

3. Bonus issue

A company announces bonus shares as a way of distributing its profits among the shareholders in lieu of dividends. A company typically announces bonus shares when they have enough reserves but may or may not have enough liquidity to distribute dividends or may want to preserve its liquidity but reward shareholders by using its reserves. Bonus shares are given by the company in the ratio of original shares held by the shareholders. 

For example, if a company announces bonus shares in the ratio of 1:1, then shareholders will get an additional share for every share held by them. The market price of the shares typically falls in the ratio of the bonus shares announced. 

Therefore, if the shares are trading at Rs.100 before bonus shares are announced in the ratio of 1:1, the shares prices post this announcement may trade around Rs. 50. However, if the company has strong financials and is backed by good fundamentals, the share prices are bound to increase in the long run. 

4. Rights issue

A rights issue is when additional shares are offered to existing shareholders of the company at a discounted price and not to the public at large for a subscription. It is typically announced by a company when it wants to raise capital to finance its expansion or meet its debt obligations but does not turn to conventional sources like loans. Similar to bonus shares, an announcement of a rights issue also triggers a fall in the share prices in proportion to the ratio of the rights issue.

5. Buybacks

A company announces a buyback of shares when it wants to purchase its shares from the open market and reduce the number of outstanding shares. The reasons for buyback can be to increase promoters’ share in the company for higher control, distribution of excess funds to the shareholders, improve EPS, etc. When a company announces a buyback of shares, the share prices of such companies usually increase as it shows demand for the shares as well as the confidence of the promoters in the company itself. 

Conclusion

Every material action that triggers a change in the composition of the company or its pathway to achieve its objectives warrants a reaction from the market at large, impacting its stock prices. However, investors should always focus on the fundamentals of the company before being swayed by the buzz around any corporate actions. This will help them in making an objective decision in determining if the shares are a good bet or not. 

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