What are Corporate Actions?
Corporate actions tend to have bearing on the price of a security. When a company announces a corporate action, it is initiating a process that will bring actual change to its securities either in terms of number of shares increasing on the hands on the shareholders or a change to the face value of the security or receiving shares of a new company by the shareholders or a change to the face value of the security or receiving shares of a new company by the shareholders as in the case of merger or acquisition etc. By understanding these different types of processes and their effects, an investor can have a clearer picture of what a corporate action indicates about a company's financial affairs and how that action will influence the company's share price and performance.
Corporate actions are typically agreed upon by a company's Board of Directors and authorized by the shareholders. Some example are dividends, stock splits, rights issues, bonus issues etc.
What is meant by 'Dividend' declared by companies?
Returns received by investors in equities come in two forms a) growth in the value (market price) of the share and b) dividends , Dividend is distribution of part of a company's earnings to shareholders, usually twice a year in the form of a final dividend and an interim dividend. Dividend is therefore a source of income for the shareholder. Normally, the dividend is expressed on a 'per share' basis, for instance - Rs. 3 per share. This makes it easy to see how much of the company's profit are being paid out, and how much are being retained by the company to plough back into the business. So a company that has earnings per share in the year of Rs. 6 and pays out Rs.3 per share as a dividend is passing half of its profits on to shareholders and retaining the other half. Directors of a company have discretion as to how much of a dividend to declare or whether they should pay any dividend at all.
What is meant by Dividend Yield?
Dividend yield gives the relationship between the current price of a stock and the dividend paid by its issuing company during the last 12 months. It is calculated by aggregating past year's dividend and dividing it by the current stock price.
Example:
ABC Co.
Share price: Rs. 360
Annual dividend: Rs. 10
Dividend yield: 2.77% (10/360)
Historically, a higher dividend yield has been considered to be desirable among investors. A high dividend yield is considered to be evidence that a stock is underpriced, whereas a low dividend yield is considered evidence that the stock is overpriced. A note of caution here though. There have been companies in the past which had a record of high dividend yield, only to go bust in later years. Dividend yield therefore can be only one of the factors in determining future performance of a company.
What is a Stock Split?
A stock split is a corporate action which splits the existing shares of a particular face value into smaller denominations so that the number of shares increase, however, the market capitalization or the value of shares held by the investors post split remains the same as that before the split. For e.g. If a company has issued 1,00,00,000 shares with a face value of Rs. 10 and the current market price being Rs. 100, a 2-for-1 stock split would reduce the face value of the shares to 5 and increase the number of the company's outstanding shares to 2,00,00,000 (1,00,00,000*(10/5)). Consequently, the share price would also halve to Rs. 50 so that the market capitalization or the value shares held by an investor remains unchanged. It is the same thing as exchanging a Rs. 100 note for two Rs. 50 notes; the value remains the same.
Let us see the impact of this on the share holder: - Let's say company ABC is trading at Rs. 40 and has 100 million shares issued, which gives it a market capitalization of Rs. 4000 million (Rs. 40 x 100 million shares). An investor holds 400 shares of the company valued at Rs. 16,000. The company then decides to implement a 4-for-1 stock split (i.e. a shareholder holding 1 share, will now hold 4 shares). For each share shareholder currently own, they receive three additional shares. The investor will therefore hold 1600 shares. So the investor gains 3 additional shares for each share held. But this does not impact the value of the shares held by the investor since post split, the price of the stock is also split by 25% (1/4th), from Rs. 40 to Rs. 10, therefore the investor continues to hold Rs. 16,000 worth of shares. Notice that the market capitalization stays the same it has increased the amount of stocks outstanding to 400 million while simultaneously reducing the stock price by 25% to Rs. 10 for a capitalization of Rs. 4000 million. The true value of the company hasn't changed.
An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide Rs. 40 by 4 and we get the new trading price of Rs. 10. If a stock were to split 3-for-2, we'd do the same thing: 40/(3/2) = 40/1.5 = Rs. 26.60.
2-for-1 Split Pre-Split Post-Split No. of shares 100 mill. 200 mill. Share Price Rs. 40 Rs. 20 Market Cap. Rs. 4000 mill. Rs. 4000 mill. 4-for-1 No. of Shares 100 mill. 400 mill. Share Price Rs. 40 Rs. 10 Market Cap. Rs. 4000 mill. Rs. 4000 mill.
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