Corporate Actions – What are the different types?
May 5, 2020
What are Corporate Actions?
Corporate actions are initiatives taken up by a corporate entity that brings in a change to its stock. There are many types of corporate actions that an entity can choose to initiate. A good understanding of these corporate actions gives a clear picture of the company’s financial health, and to determine whether to buy or sell a particular stock.
A corporate action is initiated by the board of directors and approved by the company’s shareholders.
There are many corporate actions but we will discuss some of the important ones.
1. Dividend
Dividends are paid by the company to its shareholders. Dividends are paid to distribute the profits made by the company during the year. Dividends are paid on a per-share bases. In simple word it can be taken as a profit sharing with the share holders. If the company made some good profits in a year, they have a choice either they can pay out the dividends or they can use that money to fund some other project for the betterment of the future of the company.
For example, in the financial year 2012-2013 Infosys had declared a dividend of Rs. 42 per share. The dividend paid is also expressed as a percentage of the face value. In the above case, the face value of Infosys was Rs. 5 and the dividend paid was Rs. 42 hence the dividend payout is said to be 840%.
2. Bonus Issue
A bonus issue is a stock dividend, allowed by the company to reward the shareholders. The bonus shares are issued out of the reserves of the company. These are the free shares that the shareholders receive against the shares they are already holding. These allotments usually come in a fixed ratio such as 1:1, 2:1, 3:1, etc.
If the ratio is 2:1, the existing shareholders get additional 2 shares for every 1 share they hold at no additional cost. So if a shareholder has 100 shares, he will be awarded 200 shares at no additional cost. And the total number of shares he will now have will be 300. The number of shares he hold will increase but the overall value of investment remains the same.
3. Stock Split
The word stock split – for the first time sounds weird but this happens on a regular basis in the markets. What this means is quite obvious – the stocks that you hold actually split!
When a stock split is declared by the company the number of shares held increases but the investment remains the same similar to the bonus issue. The stock is split with reference to the face value. Suppose the stock’s face value is Rs. 10, and there is a 1:2 stock split then the face value change to Rs. 5. If you owned 1 shares before split you would now own 2 shares after the split.
4. Rights Issue
The idea behind a rights issue is to raise fresh capital. However, instead of going public, the company approaches its existing shareholders. Think about the rights issue as a second IPO but for a select group of people(existing shareholders). The rights issue could be an indication of promising new development in the company.
The shareholders can subscribe to the rights issue in the proportion of their shareholding. For example, 1:4 rights issue means for every 4 shares a shareholder owns, he can subscribe to 1 additional share. Needless to say, the new shares under the rights issue will be issued at a lower price than what prevails in the markets.
The rights issue is different from bonus issue as one is paying money to acquire the shares. Hence the shareholders should subscribe to the rights issue if he or she is completely sure about the future of the company.
5. Buyback of Shares
A buyback can be seen as a method for a company to invest in itself by buying shares from other investors in the market. Buyback reduce the number of shares outstanding in the market, however, buyback of shares is an important method of corporate restructuring. There could be many reasons why corporates choose to buy back shares..
– Improve the profitability on a per-share basis.
– To consolidate their stake in the company.
– To prevent other companies from taking over.
– To show the confidence of the promoters about their company.
