Basics of Stock Market 15: Benefits of owning a share-Corporate actions
When you’re buying a share, you are effectively becoming a part-owner of the company. The increase or decrease in share price will depend on the success or failure of the company. Once the company starts to perform well, its share price appreciates, and you can sell your share to get the capital gain. This is by far the primary way of making money from the share market.
Apart from the capital gains, you have additional benefits as well. Since you have become part-owner of the company, you are entitled to have all the corporate actions like dividends, bonus issues, etc. We’ll talk about this in the below section.
Table of contents
Dividend
What is a dividend?
Suppose the company you have invested in is doing really well. The company decided to distribute a part of its profits or surplus to its loyal shareholders. This distribution is called dividends. Any amount not distributed is taken to be re-invested in the business called retained earnings.
A corporation is usually prohibited from paying a dividend out of its capital. The distribution of dividends to its shareholders may be in cash which is usually a deposit into a bank account. The dividend received by a shareholder is the income of the shareholder and may be subject to income tax.
Types of dividends
Cash dividends: The most common type of dividend. Companies generally pay these in cash directly into the shareholder's brokerage account.
Stock dividends: Instead of paying cash, corporations can also pay investors with additional shares of stock.
Dividend reinvestment programs (DRIPs): Investors in DRIPs are able to reinvest any dividends received back into the company's stock, often at a discount.
Special dividends: A company often issues a special dividend to distribute profits that have accumulated over several years and for which it has no immediate need.
Preferred dividends: Pay-outs are issued to owners of preferred stock. Preferred stock is a type of stock that functions less like a stock and more like a bond. Dividends are usually paid quarterly, but dividends on preferred stock are generally fixed.
Ex-dividend date
The ex-dividend date is extremely important to investors: Investors must own the stock by that date to receive the dividend. Investors who purchase the stock after the ex-dividend date will not be eligible to receive the dividend.
Dividend yield
Corporations often report their dividend yield, which is a measure of the company’s annual dividend divided by the stock price on a certain date.
The dividend yield allows for a more accurate comparison of dividend stocks. A ₹10 stock paying ₹0.10 quarterly (₹0.40 per share annually) has the same yield as a ₹100 stock paying ₹1 quarterly (₹4 annually). The yield is 4% in both cases.
Dividend Examples
The company publishes its dividend yield, which is in a percentage value. This percentage is calculated from its face value. Suppose TCS is paying a dividend of 700% and TCS has a face value of 1. This means TCS is paying ₹7 per share as a dividend. Please note that a TCS share is worth ₹3000+ while the dividend they provide is just ₹7 per share. So, never buy a share just for the dividend.
Another way a company publishes its dividend is directly through dividend value per share called cash dividend. From the above example, TCS will publish a dividend pay-out of ₹7 per equity share.
Final and interim dividend
There are two types of dividends paid by a corporation. Interim and final dividend.
The interim dividend is the dividend that is declared between two annual general meetings of a company. The final dividend is the dividend that is declared at the annual general meeting of the company. The rate of interim dividend is usually less than the final dividend.
Inference
To buy a company based on their dividend pay-out is all dependent on the investor's risk and style of investing. But normally an investor keeps an eye on whether a company is paying dividends regularly or not. This shows how the company is performing over the years.
Some multinational companies have never paid dividends at all. This is basically due to the philosophy of reinvesting the dividend amount into their own business.
Fact: For example, the trillion-dollar company Apple has never paid out dividends to its shareholders. What Apple says is, they will reinvest this dividend amount into their business and grow their business, thereby bringing up the stock prices.
Stock-split
What is a stock split?
A stock split is when a company divides the existing shares of its stock into multiple new shares to boost the stock's liquidity. This is mainly done to bring liquidity to the shares. These splits are denoted in ratios, ratios to the current market price.
The most common split ratios are 2-for-1 or 3-for-1 (denoted as 2:1 or 3:1), which means that the stockholder will have two or three shares after the split takes place.
How is it done?
IRCTC was trading at ₹5000 per share. This value might be huge for some traders and investors with less capital. Thus, these people stay away from these stocks. For this reason, there will be less participation in this stock, which means less liquidity on this stock.
To boost more participation, IRCTC has split its stock price by 1:5 of its original value. Now, the price is trading around ₹1000 per share. This brings in more liquidity to the stock.
How does it affect the overall valuation?
The overall market capitalization or the valuation of the stock will remain the same. It's just that now we have a greater number of shares to trade with. A company has 100 shares of ₹5000 each has a market capitalization of 100*5000=₹5,00,000.
After this, the company decides to do a 5:1 split, the new value will be ₹1000 per share. But a person with one share will now be sitting with 5 shares. Thus, new market capitalization will be 5*100*1000=₹5,00,000.
Reverse stock split
The traditional stock split is known as a forward stock split. A reverse stock split is the opposite of a forward stock split. A company that issues a reverse stock split decreases the number of its outstanding shares and increases the share price. Here also, the market value of the company after a reverse stock split would remain the same.
A company that takes this corporate action might do so if its share price had decreased to a level at which it runs the risk of being delisted from an exchange for not meeting the minimum price required to be listed.
Record date
The record date is the cut-off date established by a company in order to determine which shareholders are eligible to receive the companies benefits like dividends, stock splits, etc. The determination of record date is required to ascertain who exactly a company's shareholders are as of that date.
Bonus issue
A bonus issue is an offer given to the existing shareholders of the company. The shareholders have an option to subscribe for additional shares. Instead of increasing the dividend pay-out, or with excess profit, the companies offer to distribute additional shares to the shareholders.
This happens when the company is short of cash, and the shareholders expect regular income. Bonus issue does not involve cash flow in the company. The overall market capital increase in this case since there are more shares in the market. When a bonus issue happens, the share price of the stock is adjusted automatically.
This decrease in price makes the share more affordable to small investors and this increases liquidity in the stock.
A bonus issue is termed in ratios. A 3:2 bonus issue tells that, if an investor is holding 3 shares, he will be entitled to get an additional 2 more shares.
Rights issue
A rights issue is an issue of new shares by a company, which are offered for purchase by existing shareholders in proportion to their current holdings. This offer is generally for a stipulated period of time and at a reduced cost or discounted current market price.
A rights issue is one way for a cash-strapped company to raise capital often to pay down debt. They also look to attract more investors in this case.
Rights shares can be fully or partly paid up. Rights issue increases the share capital and shareholders of the company. This makes the stock more liquid and increases the market capitalization of the company.
When a company plans to raise capital, they announce rights offerings. This is basically telling rights issues are offered to the existing shareholders. Suppose Tata Power is trading at ₹100. The company announces the 3:10 right issue at ₹90. This means, if you're having 10 shares of Tata power, you can choose to buy 3 additional shares of Tata Power at ₹90 each.
Suppose you do not want to purchase the shares; you have the option to do this. But post rights issue, your share price will be diluted because of rights issue. Thus, not going for the rights issue might not be a good idea.
But in most cases, your rights allow you to decide whether you want to take up the option to buy the shares or sell your rights to other investors or the underwriter. Rights that can be traded are called renounceable rights. After they have been traded, the rights are known as nil-paid rights.
Share buyback
In this scenario, the company purchases the shares from its shareholders, thereby reducing the number of shares in a company.
Common reasons for a stock buyback include signaling that the company’s stock is undervalued, leveraging tax efficiency, absorbing the excess of the shares outstanding, and defending from a hostile takeover.
To be able to participate in a buyback process, the investor should be having the shares of the company in Demat form before the record date. This record date is declared by the company in its announcement for the buyback. There are two ways share buyback happens Tender offer and Open market offer.
Tender offer
Tendering is the process by which an organization that is in need of capital invites shareholders to submit a proposal or bid to provide their shares.
The shareholders need to submit their tender request by this date. The tender request is done by filling up an online buyback form and mentioning the number of shares to be tendered for buyback and the price for buyback. The minimum amount will be mentioned in the form.
The number of shares that you have tendered for buyback will be blocked for any further transaction. The company then validates this request and the shares which are not approved for buyback will be unlocked in the Demat account.
Market offer
In this process, the companies will buy back shares from the open market. This usually happens over an extended period of time.
Offer for Sale: OFS
A private company launches an Initial public offering (IPO) for additional funding. But with this, the company’s financial problems do not end and would require additional capital to meet their needs. This is the time these companies can opt to go for an Offer for Sale (OFS).
In an OFS, promoters of a company dilute their stake by selling their shares on the secondary market. Retail investors, companies, Foreign Institutional Investors (FIIs), and Qualified Institutional Buyers (QIBs) can bid on these shares.
In an OFS, the company provides a bid in order to acquire the shares. The company sets a ‘floor price.’ Buyers cannot bid at a price below the floor price. Once the bids are placed, shares are allocated to the different buyers.
Individual investors like you and me can apply in the retail category of the OFS. In this category, your total bid value should not exceed Rs 2 lakh rupees.
Retail investors are generally offered a discount in the range of 5% on the floor price when they buy shares through OFS. The discounted price is one of the key factor and investor see when he is investing through OFS.
Follow-on Public Offer: FPO
Follow on public offer or FPO is a way by which companies already listed on the stock exchange issue shares to the public. Companies go for FPO mainly to raise additional capital.
The issue price for an FPO is mostly lower than the current market price. This is done to get more participants and bring in liquidity to the share. After the FPO, the share price will eventually come down to the levels adjusting with the FPO issue price.
There are two ways in which a company can conduct its follow-on public offer:
Dilutive
Dilutive FPO is when the new offer of shares actually increases the number of outstanding shares of the company. Here the company issues a set of fresh issues to the market to increase the outstanding number of shares.
Non-dilutive
The shares issued here will be that of an already existing stakeholder's share. It might be of the directors or the bigger shareholders who sell their shares and offer them to the public. The non-dilutive FPO does not carry any material benefits for the company. Mostly it is used to change the shareholding ownership pattern of the company.
Conclusion
Although there are various benefits to owning a share, these should not be the only factor while analyzing a company for investing. You need to do a complete fundamental and quantitative approach if you’re looking for a long-term investment with the company. These additional benefits are always connected with the company size, their capital requirement, and other factors which might influence them to look into the corporate actions.