If you want to trade successfully in share markets, you should have a thorough understanding of the market fundamentals. Trading in stocks and securities also requires an understanding of the public listed company, where you are investing your hard-earned money. While purchasing stocks, you should pay close attention to the corporate actions of a company as these have a direct or associated impact on shareholders. Understanding what is corporate action will allow you to gauge the financial health of the company. This, in turn, will help you make informed decisions about purchasing and selling its stocks.
What is corporate action?
Corporate actions are taken by the board of directors of a company. These are then approved by its shareholders. These actions have a bearing on the assets of the company. Corporate actions include changing the name or brand of a company, issuing dividends, spinoffs, mergers and acquisitions etc.
Types of corporate actions:
Typically, any company can initiate three types of corporate actions. These comprise:
- Mandatory corporate action : These actions are initiated by the board of directors of a company. Though these actions have an effect on the entire company, the shareholders have a little say in the decision making process, and they generally have to accede to the decisions taken. Examples of mandatorycorporate actions include stock splits, mergers and acquisitions and issuing cash dividends.
- Mandatory corporate actionswith options: These are gain taken by the board of directors, and provide various options to the shareholders. For instance, the company can decide to offer dividends to its shareholders in the form of either cash dividends or share in its stocks. The shareholder can choose either, and in the event of the shareholder failing to exercise any option, the company can choose to enforce its default option.
- Voluntary corporate action: These are actions where shareholders can participate. Any voluntary corporate action requires active participation from its shareholders. For instance, in the case of tender offers, the company requires response from shareholders regarding their willingness to participate in the offer. Shareholders choosing to participate in the tender offer can receive a payout from the sale of tendered shares.
Corporate actions and their impact on stock markets:
You can understand the impact of corporate actions on stock markets with the following examples:
Issuance of bonus shares: This is an example of corporate action where the company provides bonus or additional shares to its shareholders. For instance, a company can decide the bonus issue of 2:1, where each shareholder with 2 shares would receive an additional share as a bonus. Usually, a company offers bonus shares to tide over liquidity issues. Though issuance of bonus shares affects parameters, like price of shares and earning per share, shareholders stand to gain in the long-term with the increase in prices of shares. Generally, bonus issues signifies the financial well being of a company, and indicates that the share prices will rise over a long-term period.
Stock splits: This is another example of corporate action, where the company splits its existing stocks into equal halves. For example, if a company with a face value of Rs 10 per share announces a stock split of 1:1, it means that every existing share has been converted into 2 shares of Rs 5 each. This corporate action is resorted to by the companies to increase its liquidity, and make its shares more affordable to small investors. A stock split can also help the company realise the true value of its shares.
Dividends: This corporate action- decided during the Annual General Meeting (AGM) – allows shareholders to get a regular income from the company. Companies share their profits with the shareholders through dividend payments, which are either a percentage of share’s face value or quoted as value per share. For instance, if the face value of a company’s share is Rs 10,and it declares a dividend of Rs 20 per share, then the dividend is 200%. In 2020, the government has made changes in the Dividend Distribution Tax, making it taxable at the end of shareholders. It is not mandatory for companies to pay dividends each year, and these could be paid either out of profits, or cash reserves.
Rights issue: This corporate action allows the company to offer new shares to its existing shareholders at discounted prices. For instance, a company can declare rights issue of 1:3, which means that one additional share can be purchased at a discounted price for every 3 existing shares. This corporate action allows the companies to raise money, though there is a corresponding fall in the price and earning of its shares.
Conclusion : Thus, knowing what is corporate action will allow you to select the investment strategy. While starting your investment journey, always remember to choose a trusted and reliable stock broker providing cutting-edge trading platforms and market research.