When you trade stocks, you must watch the companies you invest in. Their actions can directly affect your investments. Company management is responsible for achieving the company’s goals, and their decisions influence the future and stock prices. These corporate actions shape the company’s direction over time. So, it’s wise for you to understand these actions and what is stock market’s or the stock price’s reaction to these actions. Let’s begin by understanding the basics of corporate actions.
What are corporate actions?
Corporate actions are decisions made by a company’s management or Board of Directors that significantly impact the organization. These decisions can range from minor tweaks to major shifts that shape the company’s future. Examples include changes in company policy, mergers, or debt or equity restructuring.
These actions affect shareholders in different ways, either mandatorily or voluntarily, depending on the nature of the action. They also provide insight into the company’s financial health and its standing within the industry. Some corporate actions align with the company’s vision, while others respond to economic conditions that influence its operations.
How do different corporate actions impact the company’s share price?
- Stock Split and Reverse Stock Split:
Sometimes, companies try to manage their stock prices to keep them from going too high or too low. Two common ways to do this are stock splits and consolidations. In a stock split, the company issues more shares to existing shareholders. For example, in a 2-for-1 split, you’d double the number of shares you own, which should lower the stock price since more shares are available.
On the other hand, a consolidation, or reverse stock split, merges existing shares to reduce the total number, aiming to raise the price. This can signal that a company faces challenges and worries about being delisted.
For instance, if shares of Company A are at Rs. 100 and it announces a 1-for-10 stock split, the share price would drop to around Rs. 10. You’d have more shares, but the price per share would decrease. The reverse happens with a reverse stock split.
- Share Buyback:
A stock buyback happens when a company repurchases its shares from shareholders, often at a price higher than the market value. Companies do this to increase ownership, support share prices, boost earnings per share (EPS), and build investor confidence in their leadership.
When a company announces a buyback, shareholders usually feel happy. This is because buybacks lower the number of outstanding shares, meaning profits are divided among fewer shares.
As a result, EPS rises, and stock prices often increase. However, bondholders may not share this excitement. They might be concerned because buybacks reduce the company’s cash reserves and make the balance sheet less appealing. Generally, stock prices tend to react more positively to buyback announcements than bond prices.
- Company Taking Loans for Expansion:
When a company takes on debt, stockholders often see a drop in their earnings per share (EPS). This happens because the company has to pay interest on the borrowed money. However, the good news is that borrowing doesn’t increase the number of shares, so stockholders’ ownership stays the same. Stockholders can benefit if the company expands and boosts sales revenue.
On the flip side, bondholders face a decline in the value of their investments. As the company increases its debt, the perceived risk rises. This increased risk makes it more challenging for the company to meet its obligations to bondholders. So, stock prices are less affected than bond prices when a company borrows money.
- Dividend Declaration:
Dividends are how companies share their profits with shareholders. This routine process can quickly affect share prices. When a company plans to declare dividends, it must follow the Companies Act 2013, which requires passing a resolution. After that, the company informs shareholders through a notice and notifies the stock exchanges.
This announcement usually increases demand for the stock, driving the price up until the ex-dividend date. This date is the cutoff for determining which shareholders are eligible for the dividends. Once the record date passes, the demand for shares often returns to normal levels, causing prices to stabilize. So, while dividends can boost stock prices in the short term, their impact tends to balance out after the ex-dividend date.
- Right Issues:
A rights issue happens when a company offers extra shares to its current shareholders at a discounted price. This option isn’t available to the public. Companies usually announce rights issues when they want to raise money for expansion or to pay off debts, but they avoid traditional funding methods like loans.
When a rights issue is announced, you might notice the share prices drop. This decline often reflects the ratio of the new shares being offered. So, if you’re an existing shareholder, it’s essential to pay attention to these announcements, as they can affect the value of your investment.
Every action that changes a company’s structure or goals will likely prompt a market reaction, affecting its stock prices. But before you get caught up in the excitement surrounding any corporate action, focusing on the company’s fundamentals is essential. Understanding the core aspects of the business will help you make an informed decision about whether the shares are a wise investment. This way, you can stay objective and determine if it’s a good time to invest.
By understanding corporate actions, you can gain valuable insights into the company’s strategies for growth and survival. Knowing how to invest in share market with this knowledge can help you make informed investment decisions and better assess the company’s potential.
FAQs:
- What happens to the stock price when a company increases its dividend?
When a company raises its dividend, stockholders get a bigger payout. However, bonds may struggle because the company has less cash, affecting its ability to pay bondholders. So, stocks usually respond positively to this news, while bonds react negatively.
- How does bankruptcy affect stocks and bonds?
When a company files for bankruptcy, its stock typically drops sharply. Bonds also face a sell-off, but the extent varies based on the situation. The key difference is that stockholders are at the bottom of the priority list among stakeholders, which is why they often see a more significant negative reaction than bondholders.