Market pulse

By Sunil Singh

Investors frequently come across terms such as bonus, stock splits and right issues. All these are examples of what we call corporate actions (CA). 

Definition: CAs are simply actions taken by a company once agreed upon by its board of directors andthen authorized by its shareholders.All such actions have an announcement date, ex-date, and record date.

Let’s have a quick look at what these corporate actions mean which will help us in understanding their impact on a company’s share prices.

Bonus

Definition: A bonus issue is a stock dividend. A company allots these shares for rewarding its shareholders. Issued out of the company’s reserves, bonus shares are free and the shareholders receive them against the shares currently held. Allotments are typically made in a fixed ratio e.g., 1:1, 2:1, 3:1 etc.

Motivation: Companies generally give away bonus shares to boost participation of retail investors, particularly when a company’s share price has risen quite high making entry of new investors difficult. 

Example: A 2:1 bonus ratio means the existing shareholders (as on the record date) will get 2 additional shares for every 1 share held at zero cost. A shareholder holding 100 shares will get additional 200 shares free, taking his total number of shares held to 300.

On bonus issue, the number of shares held will increase but the overall value of investment will remain the same. Hence price per share reduces.

Let’s take an illustration

Therefore, bonus issue reduces share price by increasing the number of outstanding shares keeping the aggregate value same, thus making it affordable.

Stock Split

Definition: Stock split is a phenomenon wherein the face value of the stock is split into smaller denominations thereby bringing down the market price proportionally.

Motivation: Reduced price due to stock split, is a way of increasing retail participation and is a quite common phenomenon in the share market.

Example: Say the face value of a stock is Rs.10, and a 1:1 stock split is announced. Here, the face value will be split in half. But since the market value of shares remains unchanged, and the price per share has to reduce in the same proportion as the face value, the number of shares has to increase inversely. Which means a stock split of 1:1 will reduce share price by half and the number of shares outstanding will double.

Let’s take an illustration:

Due to a stock split, the number of shares held by the shareholder increases but the investment value remains unchanged just like bonus. Only the face value reduces.

Rights Issue

Definition: Rights Issue is a phenomenon in which a company, instead of going public, approaches its shareholders’ with an option to subscribe to it, in proportion to their shareholding.

Motivation: A rights issue is for raising fresh capital. It’s like an IPO for a selected group

Example: A 1:4 rights issue means for every 4 shares held, the shareholder can subscribe to 1 additional share. But unlike bonus, it comes at a cost which is lower than the prevalent market price, otherwise buying from the open market would be more sensible.

Shareholders must be convinced of the future prospects of the company, if they invest in rights issue. Usually rights issues indicate that the management is confident about future growth prospects.

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