When we purchase stock of a particular company we are basically buying an ownership into that company. Although the ownership percentage is very less but still management actions affect our profit percentage both in terms of stock price movement and corporate action taken (dividends, stock splits, bonus, share buyback etc).
Keeping a watch on these management actions can enhance our returns as stock price follows a well defined tried and tested path post the announcements. Let’s try to understand what the various types of corporate actions are and how the stock price behaves post its announcement.
Corporate action is any step taken by management team which affects the security issued by a public company. Publically traded company tries to maximize the shareholders value by taking such steps. Common types of corporate actions which enhance shareholders wealth include dividend distribution, stock splits, buybacks, and corporate restructuring via mergers and acquisitions.
Corporate actions and stock price movement
Through Dividend declaration company management distributes a part of company earning to the shareholders.
How to benefit from this news – Let’s say stock price for company A is Rs 100 today. There is a dividend declaration of Rs 2/share. That means each stock holder will get Rs 2/share as cash if he holds stocks of company A on or before Ex-dividend date. As markets react to every good news stock price of company A will reach Rs 102 or even higher before Ex-dividend date. As dividend declaration normally results in stock price appreciation, make a list of good dividend declaring companies and figure out in which quarter and round what date they declare dividends. Invest in them before dividend declaration date and benefit from price appreciation.
Share Buy Back
Share Buyback is basically reacquisition of companies own shares. Bought back shares are not available for trading. Buy back’s reduces number of shares and hence increases earning per share.
How to benefit from this news – Playing buyback is slightly tricky and you need to understand the company’s fundamentals before taking a decision.If based on your fundamental research you find out that a company is undervalued and at the same time company management announces a buyback offer its wise to invest in that stock. When the market condition improves you will reap a handsome benefit out of this investment.
Stock Split/Reverse Stock Split
This is a step to improve the liquidity of stock. If due to some reason stock price of a company is too high or too low and hence illiquid, companies announce stock splits/reverse stock splits to increase the liquidity of stocks. This basically increases or decreases the number of stocks without changing the market cap of the company.
How to benefit from this news - Stock splits/Reverse splits normally increase the liquidity of stocks and now there are more buyers and sellers for the same stock. Normally companies announce splits if they are quite confident about the future growth prospects. One can invest and benefit from this news if the company is a quality company.
This corporate action gives privilege to existing shareholders by offering them to buy additional shares of the company before going to open market.
How to benefit from this news – Normally a company offers rights issue if it requires additional capital. Investor should study the need for this capital requirement and if he feels the capital invested by the company will be profitable, he should apply for the rights issue if it’s offered at price which is considerably less that current market price of the stock.
Mergers and Acquisitions
Merger happens when two companies decide to merge and one of them surrenders its stock to other one. Acquisition happens when one company buys majority stake in Target Company. There is no surrender of stocks involved here.
How to benefit from this news - Normally whenever Target Company is acquired the acquiring company has to pay a premium for this purchase which in turn results in increase in stock price of the target company in short term. As the acquiring company has to pay the premium its stock price decreases in short term. An investor can use acquisition news to buy into Target Company and sell parent company in order to gain in short term.
Corporate actions present an opportunity to earn benefit in short term so it’s profitable to track the announcements. You need to be quick as the news gets factored into the price within no time. One should be cautious as price movements happen only for short term, so one should get out as soon as he/she is in profit.