Module 1   Introduction to Stock MarketsChapter 11

Five Corporate Actions and Its Impact on Stock Prices

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Ch11title

11.1 – Overview

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 also to determine whether to buy or sell a particular stock.

In this chapter, we will be looking into the five most important corporate actions and their impact on stock prices.

A corporate action is initiated by the board of directors and approved by the company’s shareholders.

dividend111.2 – Dividends

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 basis. For example, during the financial year, 2012-13 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% (42/5).

It is not mandatory to pay out dividends every year. If the company feels that instead of paying dividends to shareholders they are better off utilizing the same cash to fund a new project for a better future, they can do so.

Besides, the dividends need not be paid from the profits alone. If the company has made a loss during the year but it does hold a healthy cash reserve, then the company can still pay dividends from its cash reserves.

Sometimes distributing the dividends may be the best way forward for the company. When the growth opportunities for the company have exhausted and the company holds excess cash, it would make sense for the company to reward its shareholders thereby repaying the trust the shareholders hold in the company.

The decision to pay dividend is taken in the Annual General Meeting (AGM) during which the directors of the company meet. The dividends are not paid right after the announcement. This is because the shares are traded throughout the year and it would be difficult to identify who gets the dividend and who doesn’t. The following timeline would help you understand the dividend cycle.

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Dividend Declaration Date: This is the date on which the AGM takes place and the company’s board approves the dividend issue

Record Date: This is the date on which the company decides to review the shareholders register to list down all the eligible shareholders for the dividend. Usually, the time difference between the dividend declaration date and the record date is at least 30 days

Ex-Date/Ex-Dividend date: The ex-dividend date is normally set two business days before the record date. Only shareholders who own the shares before the ex-dividend date are entitled to the dividend. This is because in India the normal settlement is on a T+2 basis. So for all practical purposes if you want to be entitled to receive a dividend you need to ensure you buy the shares before the ex-dividend date.

Dividend Payout Date: This is the day on which the dividends are paid out to shareholders listed in the register of the company.

Cum Dividend: The shares are said to be cum dividend till the ex-dividend date.

When the stock goes ex-dividend, usually the stock drops to the extent of dividends paid. For example, if ITC (trading at Rs. 335) has declared a dividend of Rs.5. On ex-date, the stock price will drop to the extent of dividend paid, and as in this case, the price of ITC will drop down to Rs.330. The reason for this price drop is because the amount paid out no longer belongs to the company.

Dividends can be paid anytime during the financial year. If it’s paid during the financial year it is called the interim dividend. If the dividend is paid at the end of the financial year it is called the final dividend.

bonus-issue11.3 – Bonus Issue

A bonus issue is a stock dividend, allotted by the company to reward the shareholders. The bonus shares are issued out of the reserves of the company. These are free shares that the shareholders receive against shares that they currently hold. These allotments typically come in a fixed ratio such as 1:1, 2:1, 3:1, etc.

If the ratio is 2:1 ratio, the existing shareholders get 2 additional shares for every 1 share they hold at no additional cost. So if a shareholder owns 100 shares then he will be issued an additional 200 shares, so his total holding will become 300 shares. When the bonus shares are issued, the number of shares the shareholder holds will increase but the overall value of an investment will remain the same.

To illustrate this, let us assume a bonus issue on different ratios – 1:1, 3:1 and 5:1

Bonus Issue No of shares held before bonus Share price before Bonus issue Value of Investment Number of shares held after Bonus Share price after Bonus issue Value of Investment
1:1 100 75 7,500 200 37.5 7500
3:1 30 550 16,500 120 137.5 16,500
5:1 2000 15 30,000 12,000 2.5 30,000

Similar to the dividend issue there is a bonus announcement date, ex-bonus date, and record date.

Companies issue bonus shares to encourage retail participation, especially when the price per share of a company is very high and it becomes tough for new investors to buy shares. By issuing bonus shares, the number of outstanding shares increases, but the value of each share reduces as shown in the example above. The face value remains unchanged

stocksplit11.4 – 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 are split!

When a stock split is declared by the company the number of shares held increases but the investment value/market capitalization 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 will change to Rs.5. If you owned 1 share before split you would now own 2 shares after the split.

We will illustrate this with an example:

Split Ratio Old FV No of shares you own before split Share Price before split Investment Value before split New FV No of shares you own after the split Share Price after the split Investment value after the split
1:2 10 100 900 90,000 5 200 450 90,000
1:5 10 100 900 90,000 2 500 180 90,000

Similar to a bonus issue, a stock split is usually to encourage more retail participation by reducing the value per share.

rightissue111.5 – 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.

However, a word of caution – The investor should not be swayed by the discount offered by the company but they should look beyond that. A rights issue is different from a bonus issue as one is paying money to acquire shares. Hence the shareholder should subscribe only if he or she is completely convinced about the future of the company. Also, if the market price is below the subscription price/right issue price it is obviously cheaper to buy it from the open market.

buyback11.6 – 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. Buybacks 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…

  1. Improve the profitability on a per-share basis
  2. To consolidate their stake in the company
  3. To prevent other companies from taking over
  4. To show the confidence of the promoters about their company
  5. To support the share price from declining in the markets

When a company announces a buyback, it signals the company’s confidence about itself. Hence this is usually positive for the share price.


Key takeaways from this chapter

  1. Corporate actions have an impact on stock prices
  2. Dividends are a means of rewarding shareholders. The dividend is announced as a percentage of the face value
  3. If you aspire to get the dividend you need to own the stock before the ex-dividend date
  4. A bonus issue is a form of the stock dividend. This is the company’s way of rewarding the shareholders with additional shares
  5. A stock split is done based on the face value. The face value and the stock price changes in proportion to the change in face value
  6. A rights issue is a way through which the company raises fresh capital from the existing shareholders. Subscribe to it only if you think it makes sense
  7. Buyback signals a positive outlook of the promoters. This also conveys to the shareholders that the promoters are optimistic about the company’s prospects.

665 comments

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  1. DA2301 says:

    First of all many thanks for sharing knowledge in a format which everyone can understand.
    I have a doubt on your below impact on stock price due to dividend payment –
    “When the stock goes ex dividend, usually the stock drops to the extent of dividends paid. For example if ITC (trading at Rs. 335) has declared a dividend of Rs.5. On ex date the stock price will drop to the extent of dividend paid, and as in this case the price of ITC will drop down to Rs.330. The reason for this price drop is because the amount paid out no longer belongs to the company.”
    If this is so easy then will it not create a shorting opportunity just before the ex-dividend date if the dividend amount is significant?

    • Karthik Rangappa says:

      Thanks for your kind words.

      With respect to shorting just before ex-dividend..its not so easy. Think about it, everybody attempts to do the same 🙂

    • teena patidar says:

      If someone bought shares of BEL yesterday (27th SEPT). will the shares be delivered with price adjusted for ex bonus. I mean deliveries for BEL yesterday were at 60% so all those who bought were already aware that tomorrow price will go down 10%.. so why they’d take such a risk ?
      I’m thinking that during delivery of these shares the price should be adjusted to ex bonus.. or is it not ?

      Thanks in advance for the info.
      Cheers!

    • osman says:

      I have a question wit regards to dividend…I some where read on google DAT stock price will get reduced to the extent of percentage declared…ex:if 300 price stock company declared 40% of face value 10…den stock price will reduced to 40%..which is Rs.120 …is it true…plz provide some info…thanks in advance

      • Karthik Rangappa says:

        No, 40% is calculated on the face value. So that would be 40%*10 = 4. Hence, the stock price may reduce to 300-4 = 296. However, you may not experience this for small dividend payouts. Happens when large dividends (special dividends) are paid out.

  2. How can we call the Bonus Issue as a reward to shareholders when the value of investment is not increasing?

    Thanks

    • Karthik Rangappa says:

      With the Bonus issue the number of shares increases, this means when dividends are issued you earn more money 🙂

      • Ankit Jain says:

        Does the Face Value remain the same on bonus issue?

        • Karthik Rangappa says:

          Yes, it does.

          • Srihari says:

            Karthik. first of all thanks for the info sharing. Really fantastic initiative.
            My question to your response for
            So, what is the difference between Bonus issue and Stock Split? seems to be a very thin line.
            1) The value of investment is not increasing in both cases.
            2) The # of shares remains the same

            So the difference is the change value remains same in Bonus issue and reduces in Stock split?

          • Karthik Rangappa says:

            Bonus issue – you get additional shares against what you already hold. This is also considered as a dividend in the form of new shares issued. The split is dividing the shares. Both cases number of shares increases, value remains the same.

  3. Vinay says:

    Hi,
    Thanks for the great initiative by zerodha.
    Its really helpful.
    I have a doubt on these topics- bonus issue and stock split.
    In both the cases the number of shares we are holding increases but the value remains the same?
    Except the face value decreases by stock splits.
    Are there any other differences between bonus issue and stock split.
    Please explain.

    Thanks.

    • Karthik Rangappa says:

      Yes, the investment value remains the same. In stock split, the Face value reduces and in Bonus issue it does not. In both the cases. This helps in realizing a higher dividend value.

      • Raghavendra says:

        How does Stock Split and Bonus shares help us realize more dividend value.
        According to my understanding,
        Consider before Stock Split FV of a XYZ share is 10. Dividend announced would be 1000% ie Rs 100 per share. After Stock Split FV would be 5 and 2X shares. Dividend announced would be 1000% ie 5*2*10 = 100 for 2 shares. Dividend would not increase right.

        In case of Bonus since FV does not decrease the Dividend realization increases right?.

        • Karthik Rangappa says:

          That right. Maybe I need to rewrite this bit. But there is another angle here – capital appreciation, especially for companies with strong capital structure and business model. For example Relaxo Footware was trading around 800 in early 2014..the stock split and the value dropped to 175. The number of shares increased and the stock continued to rally…its back to 800 now, so in the whole process massive wealth has been created. This is one of the advantages of stock split.

        • VRN says:

          Hi,
          Here I am not able to understand 5*2*10. What is 10 in this case ?

      • tanmay says:

        Hi Karthik,

        Please mention this is the module, in case of stock split the face value also splits, while in case of bonus shares the face value remains the same. Otherwise both look exactly the same just the name difference.

        And thanks I have been confused for a long time about these, only came to know from the comments.

  4. Raju Shinde says:

    “Only shareholders who own the shares before the ex dividend date are entitled to the dividend.”
    If I bought the shares 4 days before the AGM and sell on AGM day, still I am entitled to get the dividend?

  5. SIva says:

    How a 5:1 bonus will be issued, if a investor has 4 shares or 21 shares. Do the investor lose benefit for some shares in this case? If so, will that money be moved to share capital from surplus or not?.

    • Karthik Rangappa says:

      A 5:1 bonus indicates 5 additional shares are being issued for every 1 shares. If the investor has 4 shares (before issue), he would get 20 additional shares, likewise if you held 21 shares.

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