Corporate Actions

A corporate action is an event initiated by a public company that is expected to have a material impact on the securities (stocks and bonds) issued by the company, as well as its stakeholders, including shareholders and bondholders. Corporate actions are generally decided upon by a company's board of directors and are authorised by shareholders. There are many types of corporate actions that a company can initiate, such as dividends, stock splits, share buybacks, and rights issues. A good understanding of these corporate actions can give investors a clearer picture of a company's financial situation, how these actions can affect the company's stock price and performance, and whether to buy or sell a particular stock. In this section, we take a closer look at some of the most common corporate actions.

Dividends

The concept of dividends is not at all difficult to understand. When companies generate profits from their businesses, they distribute a portion of their earnings to shareholders as dividends, either as cash payments or stock dividends. Dividends are a way to ensure that shareholders are rewarded for their investment when companies do well. While there is no guarantee that dividends will be paid out every year, most companies have in place a dividend policy that provides the management with guidance on the proportion of earnings to pay out to shareholders as dividends. Even the tech behemoth Apple Inc, which has long disdained dividends under the leadership of Steve Jobs, took the unprecedented decision to declare its first dividend in 2012. When a dividend is declared and paid, the stock price is usually adjusted downward by the dividend amount on the ex-dividend date. Investors who purchase the stock after the ex-dividend date will not be entitled to the dividend payment.

Stock Splits

As its name suggests, a stock split is a decision by a company to divide each of its outstanding share into multiple shares. For instance, a company that announces a 2-for-1 stock split will distribute an additional share for every outstanding share that an investor holds. The end result of this split is a doubling of a company's total outstanding shares, although the split ratio is ultimately determined by the board of directors and can be different across stock splits. While a stock split increases the total number of a company's outstanding shares, its value is not affected because the market price of each share is adjusted downward accordingly. More often than not, the intent behind a stock split is to improve the liquidity of a company's stock. The decrease in the share price following the split will make the stock more attractive and accessible to a wider pool of investors, while the increase in the total number of outstanding shares will make the stock more available to interested buyers.

Share Buybacks

A share buyback is the opposite of a stock split. In a share buyback, a company repurchases its shares from the marketplace, reducing the total number of outstanding shares and giving the remaining shareholders a larger percentage ownership of the company (which usually leads to a rise in share price as earnings per share is boosted by the share buyback). There are a few ways through which a company can buy back its own shares, but the most common ones are perhaps open market share buybacks, in which a firm buys its stock on the open market at the prevailing market price, and from existing shareholders through a tender offer. The repurchased shares are either cancelled or held as treasury shares, and are no longer outstanding.

There are a couple of reasons why companies conduct share buybacks. If a company's stock is undervalued, they may take advantage of cheap valuations and buy back shares at a reduced price, with the intention to re-issue these shares when prices eventually recover. This will help the company to increase their capital without issuing new shares. If the management is of the view that there are currently no good opportunities to invest their excess cash in, they will want to return the capital to investors through share buybacks instead of just sitting on the cash. As share buybacks can potentially lead to share price increases, they benefit existing shareholders through capital appreciation.

Rights Issues

A rights issue takes place when a company gives its existing shareholders the right to purchase additional shares in the company in proportion to their holdings within a certain time period, at a fixed price that is usually set at a discount to the current market price of the stock. Companies generally offer rights when they need to raise additional capital for various reasons, such as paying off debts and funding acquisitions. The rights, however, are not obligations and do not need to be exercised if the shareholder does not wish to provide additional capital. In such cases, the shareholder can either choose to sell the rights on the open market or ignore the rights issue, although the latter is usually not recommended as shareholders will experience dilution in the value of their existing shares.