How corporate actions impact stock price

Synop sis
S tock spl its ar e anno unced by companies to make their shar es affor dable to small r etai l
inv est ors and make them mor e l iquid.

Investors need to understand the

impact of corporate actions—events
initiated by a company that impact its
share price—to get their investment
strategy right.

“A good understanding of these actions

gives a clear picture of the company’s
The impact o n a sto ck’ s price depends o n the
reaso ning behind a particular co rpo rate actio ns— nancial health, its ethical business
ev ent initiated by a co mpany .
conduct, and also helps determine
whether to buy or sell a particular
stock,” says Ajay Kejriwal, President,
Choice Broking.

Here we explain some of the prominent corporate actions and how they impact stock pri ces.

1. BONUS SHARES
These are additional shares gifted by a company to its shareholders. A 1:1 bonu s iss u e impl ies tha t shareholders
ge t one additi onal share for eac h share th a t th ey al ready hold. Generally, w hen a comp any faces l iquidity
issues or is not i n a p osi ti on to distribute th e div idends, it issues bon us shares out of its pro ts or reserves.

But there are no fr ee lunches. In case of a bo nus issue, the sh are pric e of the
co mp any fall s in the same proportion as the bo nus sh ares issued. So, i n a 1:1
bon us issue, the sh are pric e w ill fall by 50 %. Other metric s, such as earni ngs
per share (EPS ), w il l also go dow n. H ow eve r, o ver the l ong term, and as stock
price increases, i nves tors tend to gain . There is no ta x o n all otmen t of bon us
sh ares. Bonus issues are gen eral ly an in dic a tor of a co mp any’s go od heal th
an d show tha t its earnings w ould rise ov er the next 2-3 years.
There’s increased interest in buying shares of companies after they announce
bonus shares, but experts advise against investing into a company just for the
sake of additional shares. “Do check the company’s recent earnings growth
trajectory and visibility, capital expenditure (capex) plans, and schedule of
commissioning of capex plans before buying its shares,” says Deepak Jasani,
Head, Retail Research, HDFC Securities.
Impact : The share price falls in the same proportion as the bonus issue ratio.

How corporate actions impact stock price

The impact on a stock’s price depends o n the reaso ning behind a parti cular
action.

2. RIGHTS ISSUE
In a rights issue, fresh shares are issued by a company to its existing
shareholders. But unlike bonus shares, they come at a price— usually a
discounted price. To illustrate, a 1:5 rights issue implies that you are entitled
to buy one additional share for every ve shares you hold. “Cash-strapped
companies generally turn to a rights issue to raise money,” says Divakar
Vijayasarathy, Founder and Managing Partner, DVS Advisors.

It could either be for debt reduction or to nance the company’s expansion.

Do check out the reason for rights issue before you opt for it, also make sure
the company has a strong earnings visibility and a credible management. The
tax treatment is similar to that of bonus shares.

Impact : The share price falls in the same proportion as the rights issue.

3. STOCK SPLIT
It refers to a split in the stock into two or more equal portions. Stock splits are
generally announced by companies to make their shares a ordable to small
retail investors and thus make them more liquid. “Once liquidity increases,
more buyers and sellers trade in the stock, which, in turn, helps discover its
true value,” says Nikhil Kamath, Head of Trading, Zerodha.

The stock is split keeping in mind its face value—not market value. For
instance, if the stock’s face value is Rs 10, and there is a 1:1 split, its face value
will change to Rs 5. Accordingly, the market value also gets adjusted. “Stock
splits make sense only when the share price of a company is quite high, say
above Rs 1,000-1,500. In other cases, the investor has to question the logic of
the company for a stock split—in an era where investors can buy even one
share from the market,” says Jasani. A stock split does not result in any
additional tax liability on the investor.

Impact : The share prices gets slashed in the accordance with the stock split
ratio.
4. DIVIDENDS
Dividends are a form of regular income paid to shareholders by a company
out of its pro ts and reserves. Also, when a company does not nd any
appropriate investment opportunity to deploy its funds, it declares a
dividend to share its pro ts/reserves with the shareholders. Dividend is
usually quoted per share or as a percentage of the face value of the share.

For instance, if a company declares a dividend of Rs 10 per share, whose face

value is Rs 10, the dividend is 100%. Investors’ dividend income above Rs 10
lakh is taxed at 10%. Companies are required to pay a Dividend Distribution
Tax (DDT) at 20.93%.

Impact : Share price usually declines in line with the level of dividend paid
per share.

5. BUYBACKS
It is an event when the company purchases its shares from shareholders,
usually at a premium to the market price. Companies go for buybacks to
consolidate their stake in the enterprise and for greater control, to support
the share price from declining, to improve earnings per share (as it reduces
the number of outstanding shares in the market), or/and to build investor
con dence in the promoters.

Before you participate in buyback opportunities, ascertain the reasons why a

company is doing it. “We have seen IT companies like TCS and Wipro which
have underperformed the indices over the last year doing buybacks,” says
Kamath. The tax treatment in the case of buybacks through a stock exchange
is same as during a usual sale: Short-term capital gains are subject to 15% tax,
while long-term capital gains are tax-free

Impact : A buyback may lead to a short-term spike in the share price.