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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