A corporate action is a decision made by a company’s board of directors. It is usually done with the approval of shareholders and causes a significant change to the company. We can group these actions into two types: “monetary” and “non-monetary”. Monetary actions, like paying dividends or issuing right shares, have a direct financial impact on the company and shareholders. Non-monetary actions, like changing the company’s name, don’t involve money and thus don’t have a big effect on the stock price.
 

For investors, it is necessary to track these actions as they influence the company’s stock price and future. In this article, let’s study the 5 major corporate actions and their impact on the stock price.

• When a company pays dividends, its stock price usually drops by the dividend amount. This happens due to a reduction in company cash reserves.
  

• Stock splits and bonus shares increase the number of shares held, but adjust the share price so that your total investment value remains unchanged.

• Rights issues offer discounted shares to existing investors.

• In the corporate action of buybacks, a company repurchases shares at a premium from the open market.

Corporate actions are significant events that are mostly related to dividends, stock splits, bonus issues, rights issues, and buybacks. Let’s understand how they impact the stock prices of a company:
 

1. Dividends

Dividends are payments that a company makes to its shareholders from its profits. It is like a regular income that shareholders receive based on how many shares they own. Dividends can be given as:

• A fixed amount for each share
  or
• Percentage of the share’s face value

When a company declares a dividend, the stock price usually falls by the amount of the dividend. This happens because the company distributing profits reduces its cash reserves, which affects the stock price.
 

2. Bonus issue

A bonus issue is when a company gives its shareholders additional shares for “free”. For example, in a 1:1 bonus issue, for every share a person owns, they receive one more share. This means that if you hold 50 shares, you will now have 100 shares after the bonus issue. However, please note that the value of each share is adjusted. So, the total value of your investment stays the same.

That is, say you had 50 shares worth Rs. 10 each. Now, after the 1:1 bonus, you will now own 100 shares worth Rs. 5 each. Although the share price drops, the total value of your investment (Rs. 500) remains unchanged.

It is worth mentioning that the lower share price makes it easier for small investors to buy shares and increases accessibility.
 

3. Stock split

In the corporate action of a stock split, a company splits or divides its currently issued shares into several smaller shares. For an investor, this action causes the number of shares to increase, but the total value of the investment remains the same.
 

For example,

• Say a company declares a 1:2 stock split.
• This means each share is split into two.
• So, if you held 25 shares before the split, you will have 50 shares afterwards.
• Importantly, the face value of each share will be halved (from Rs. 10 to Rs. 5).
• This causes the total value of your investment (Rs. 250) to remain unchanged.

Generally, stock splits happen when a company’s stock price becomes too expensive. This high price makes it difficult for small investors to buy shares. By splitting the stock, the company reduces the price per share, which increases liquidity and attracts more investors.
 

4. Rights issue

A rights issue is a corporate action where a company offers additional shares to its “existing shareholders”. This gives them the chance to buy more shares at a discounted price. Right shares are different from bonus shares, as shareholders have to pay to acquire the right shares.

For example,

• Say a company announced a 1:5 rights issue
• This means you can buy 1 new share at a discounted price for every 5 shares you already own.

As a tip, investors should always evaluate the company’s future prospects before deciding to invest in these additional shares.
 

5. Buyback of shares

In a buyback of shares, a company buys back its own shares from the open market. Usually, this happens at a higher price than the current market rate. This event reduces the total number of shares available in the market, which often increases the earnings per share (EPS).

It is worth mentioning that the company making a buyback is seen positively in the market. That’s because it reflects the company’s confidence in its financial strength. Also, it shows that the company believes its shares are “undervalued”.

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For instance, if your objective is diversification of portfolio, the right approach towards selecting an ETF should be to opt for one that you do not already have exposure to in your portfolio. An ETF that tracks all the major companies and stocks of that particular industry will help you achieve diversification.
 

Similarly, for some investors, the objective could be investing in equity instruments since they are already heavily invested in debt investments. Hence, understanding your motivation behind investing in ETFs is essential. Here are a few questions you could ask yourself to make better decisions:

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After answering the above questions, you will have a better understanding of which ETFs will meet your unique needs and demands. You will be better able to compare different ETFs and zero in on the ones that are most suitable for your current plans.