Corporate actions can be described as any event or decision by a company’s board of directors, which impacts the shareholders and, consequently, the price of the stock. Therefore, corporate actions change the shape, health, or even prospects of a company. They have the ability to create new opportunities or risks for investors, enabling them in making the right kind of investment.
Understanding corporate actions is an essential part of investment decisions, especially for those who have recently entered the world of finance. Let’s outline the various corporate actions and observe their impact on the stock price.
1. Dividends
One of the most widely known types of corporate actions is the dividend. As soon as the company has started performing and making profits, it becomes free to distribute part of the profits to its owners in the form of dividends. Dividends may be paid in cash or in other forms as additional shares.
Consequent effect on stock price: Declaration of dividend leads to an increase in the price of shares because it will be reflected that the company is earning and, therefore, financially sound. Dividend-paying stocks are also quite attractive to investors because these provide a continuous income flow. Nevertheless, the date known as “ex-dividend date” is typically considered when the closing date to receive declared dividends comes. It then decreases the price of the stock by the amount declared as a dividend. It falls for this reason: because post ex-date, new buyers do not get the dividend, so the stock is relatively cheaper compared to the old buyers.
Example: Suppose Company X declares a $1 dividend per share. Investors who own the stock before the ex-dividend date will receive this payment. On the ex-dividend date, however, the price of stock may go down by $1 as it reflects the amount of value paid out in form of dividend.
2. Stock Splits and Reverse Stock Splits
A stock split and a reverse split alter the number of shares issued but do not alter the market value of the company. A firm implements a stock split by issuing more shares, thus lowering the price per share. The most common type of such split is called the 2-for-1 split. This signifies that the original share is divided into two, and, consequently, the price of the share halves. On the other hand, a reverse stock split reduces the outstanding number of shares and raises the price per share-for example, through a 1-for-2 split, which consolidates two shares into one.
Effect on Stock Price: Stock splits make shares cheaper to a wider set of investors, which may increase demand and drive the stock price up over time. Companies engage in the use of stock splits so as to entice smaller investors without any implication on the real value of their investment. Reverse splits, however are sometimes considered a negative signal since companies with very low stock prices may use a reverse split so as to achieve minimum price requirements on their stock exchanges.
Example: Example, if Y Company’s stock is trading at $100 and the company declares a 2-for-1 split. The price of each share would now be $50, thus doubling the number of shares. This makes stock accessible to a larger investor base.
3. Mergers and Acquisitions (M&A)
Mergers and acquisitions are the process by which one company merges with or acquires another. When two firms merge, they combine into a new firm. Acquisition involves the takeover of another firm’s identity by one firm. In most cases, M&A activities are part of a firm’s strategy toward the expansion of market share, diversification, or entry into other markets.
Impact on Stock Price: Once the targeted company decides it wants to be acquired, then its stock price often rises because this acquisition premium is given by the acquiring company to buy it. The premium brings shareholders of the acquired company a good price for their equity and persuades them to sell it. Of course, its stock price will go up or down depending upon how investors think the strategic benefits and costs of the acquisition benefit or harm the acquiring company. M&A can be a double-edged sword; it may bring growth potential, but it also might come with the sword of high debt or integration challenges.
Example: In this instance if company A is bought out by company B at a premium value then the value of its stock in company B may tend to jump considering that shareholders are realizing value from the buyout. Company A’s stock price could change with market opinion about the acquisition.
4. Rights Issues
A rights issue is when companies raise additional capital using the mechanism by which existing shareholders are issued with rights to purchase more shares at a discounted price. This increases the number of issued shares, which may temporarily dilute the value of the stocks.
The dilution in stock price primarily takes place in a rights issue; it is affected by the objective of issuing capital. If the enhancement or strengthening of the balance sheet is being used to raise capital, then investors might take this as a good signal, and the stock price would soon recover. If the rights issue reflects weak financial conditions of the firm, then it would drag down the stock.
For example, if company Z offers rights to buy shares at 10% discount, shareholders may initially suffer a loss on the value of their holdings but can buy more shares to maintain ownership percentage.
5. Buybacks or Share Repurchases
In a buyback, the company buys its shares from the market, which reduces the number of outstanding shares issued. This automatically increases the per-share ownership percentage available for the remaining shareholders and generally increases EPS.
Stock Price Impact: Buybacks are regarded as positive by investors as a firm is sending the message that it believes its stock is underpriced. It reduces outstanding shares, which means that EPS will be improved, all this and much more can push the stock upwards. Showing the firm’s confidence in future prospects makes the stock appealing even to more investors, thereby pushing the price up.
Example: If Company Q repurchases 10% of its outstanding shares, then this can build up demand and support the price because of improved EPS.
6. Spin-Offs A spin-off occurs when a firm creates a new, independent company by splitting off a division or subsidiary and distributing shares of the new entity to the shareholders. The spin-offs allow each company to focus on its core business.
Market Impact: Spin-offs are usually well welcomed by the market since they unlock shareholder value. The stock price of the parent firm would probably go up because it is leaner with one core competency, while the new firm could attract investors who wish to get into that particular sector or operation.
Example: Company M de-merges its technology division to spin it into a new company, TechCo. Each company will benefit since each focus on its strength, and shareholders find value in the split.
Conclusion
It is crucial for an investor to understand corporate actions such as dividends, stock splits, M&A, rights issues, buybacks, and spin-offs because these directly and indirectly affect a company’s stock prices as well as communicate the strategic direction of a company. The Investor replies with the action: positive actions that lift confidence, stock price, and buy investor confidence to see such investments, for example, forward earnings and buybacks; uncertain actions, such as reverse splits or rights issues, which raise investor concerns. An investor who knows the corporate actions helps his or her investment by purchasing the shares according to the financial health of the firm and its future plans when investors should buy, sell, and hold.