rights issue: Rights issue, share buyback, bonus share: What to read into these corporate actions | #corporatesecurity |


By DK Aggarwal


A lot of things that a company does can affect its share price. And when a company plans some corporate actions like a rights issue, share buyback or bonus share issue, it can have an immediate impact on share price.

It is important for shareholders to have an good understanding as to what such corporate actions mean and how can they affect a company’s share price and financial performance.

Due to their very nature, corporate actions can have significant impact on share prices and trading activity in a firm’s security on the day of announcement.

Corporate actions like right issue, share buyback and bonus shares have become commonplace nowadays. Now, the question that comes to mind is what should one read into these actions and why a company goes for such corporate actions. Market participants are increasingly recognizing the advantage that accurate and timely information on corporate actions can provide in implementing trading strategies.

When a company comes out with a rights issue, it gives shareholders a chance to increase their exposure to the stock at a discounted price. When a rights issue is offered, the stock price gets diluted and will likely go down as more shares are issued to the market.

Only shareholders on a given date, known as ‘record date’, will have the right to buy rights issue shares. Subscribing to a rights issue offer is just like investing in a stock. We should not opt for the rights issue just because of the price discount, instead one needs to look at other factors such as growth prospects and the reason behind the company’s decision to come out with the rights issue and so on.

Share buyback is basically re-acquisition of the company’s own shares. A buyback improves the confidence of investors in the company, thus it usually help the stock price to rise. A company may buy back either through tender route or open market route. Under the direct tender route, shareholders can tender their shares at a higher buyback price and can avail the benefit of the price difference. In the open market route, the management buys shares from the market and an existing shareholder cannot take any advantage of it. Price movement of a stock after the buyback announcement depends on valuations. You should not buy shares just because the company is working out a buyback plan. Before participating in a share buyback, one should study the company and take an informed decision based on its ability to generate profits.

It is important to look at the size of the buyback offer, buyback price and the duration of the offer. If the buyback size is too small compared with the overall market capitalization of the company, the impact on the stock price could be very small.

Bonus share issue is a kind of gift of additional shares by a company to its shareholders without any additional cost, based upon the number of shares a shareholder owns. For example, a 1:1 bonus issue announced by the company would imply shareholders would get one additional share for each share held. Bonus share is issued only when a company accumulates a large cash reserve, i.e. reserve not set aside for any specific purpose and can be distributed as dividends.

But does a higher number of shares increases the value of one’s investment in the company? No. Remember, there are no free lunches. A bonus issue does not involve cash flow into the company. It does not increase net assets of the company, but only share capital. The share price of the company falls in the same proportion that the bonus shares are issued. The absolute book value of the company remains the same, but due to the increase in the number of outstanding shares, the book value per share falls. The stock movement after a buyback announcement depends on valuations and can differ from company to company.

Investors should have a good understanding of these corporate actions if they want to participates in such activities. Corporate action gives a clear picture of the company’s financial health and corporate governance standards. Understanding corporate actions can help an investor determine whether to buy or sell the stock in question.

Chairman and MD, SMC Investments and Advisors





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