Five Important Decisions of Companies and Their Impact On Share Prices

Brief Description

Many decisions of companies affect its shares. A closer look at these decisions gives you a lot of information, including the financial condition of the company. Based on these decisions, you can also decide whether to buy or sell shares of the company.

In this chapter, we will look at five such important decisions of companies and understand their impact on share prices.

Such decisions are taken by the Board of Directors of the company and approved by the shareholders of the company.

Dividends

The profit earned by the company in a year is distributed among the shareholders and this is called a dividend. The company pays dividends to its shareholders. A dividend is paid on a per-share basis. For example, in 2012-13, Infosys paid a dividend of Rs 42 per share. A dividend is also seen as a percentage of the face value of the stock. For example, in the example of Infosys, the face value of the share was Rs 5 and the dividend was Rs 42, ie the company paid a dividend of 840% (42/5).

It is not necessary for the company to pay dividends every year. If the company feels that instead of distributing the profit of the year as a dividend, that money should be used for new projects and a better future, then the company can do so.

Dividends are not always paid out of profits. Sometimes the company does not make profits but has a lot of cash lying around. In such a situation, the company can also pay dividends out of that cash.

Sometimes paying dividends is the best move for the company. When the company does not have any right way to expand the business and the company is cash-strapped, it is good to reward the shareholders by paying dividends. This increases the confidence of the shareholders in the company.

The decision to pay dividends is taken in the Annual General Meeting (AGM), where the directors of the company meet. The dividend is not paid at the same time as the dividend is announced because the buying and selling of shares are going on continuously on the exchange and in such a situation it becomes difficult to ascertain who is to be paid and who is not.

Dividend Declaration Date: This is the day when the AGM meets and the board approves the dividend.

Record Date: This is the day on which the company looks at its records and decides to pay dividends to the shareholders whose names are there. There is usually a gap of at least 30 days between the declaration of dividend and the record date.

Ex-Dividend Date: This is usually two business days before the record date. This happens because in India the settlement takes place on T+2 basis i.e. two days after the transaction. So if you want a dividend then you have to buy the shares before the X dividend date.

Dividend Payout Day: Dividend is paid to the shareholders on this day.

Cum Dividend: Shares till the X dividend date are called Cum Dividend.

When stock X becomes a dividend, its price usually falls by equal to the amount of the dividend. For example, if the share of ITC is at Rs 335 and the company has declared a dividend of Rs 5, then on the ex-dividend date, the share price may fall to Rs 330 as the company no longer has these Rs 5.

Dividends can be paid anytime during the financial year. If the dividend is paid in the middle of the year then it is called the interim dividend and if it is paid at the end of the year then it is called a final dividend.

Bonus Issue

Bonus issue is a type of stock dividend that a company pays to reward its shareholders. In this, the company does not give money like dividends but shares. The company issues these shares from its reserves. Bonus shares are given free of cost and are given to the shareholders on the basis of the number of shares held by them in the company. Bonus shares are usually issued in a specific ratio like 1:1, 2:1, 3:1 etc.

If the ratio is 2:1, the shareholder gets two more shares for each share. Meaning that if the shareholder has 100 shares then he will get 200 more shares and he will have 300 shares in total. This increases the shares held by him but does not increase the value of his investment.

Take a look at the chart below to understand this properly.

Bonus Issue	Before Bonus Share Quantity	Before Bonus Share Price	Investment Value	After Bonus Share Quantity	After Bonus Share Price	Investment Value
1:1	100	75	7500	200	37.5	7500
3:1	30	550	16500	120	137.5	16,500
5:1	2000	15	30000	12000	2.5	30000

Like dividend, the bonus also has an announcement date, ex-bonus date, and record date.

Companies also come up with bonus issues to increase the participation of retail investors in the stock especially when the share price has reached a high level and the small investor is finding it difficult to buy the shares. With the arrival of a bonus issue, the number of shares in the market increases but its value falls, although the face value of the share does not change.

Stock Split

Share split is a common phenomenon in the market. In this, one share is converted into a few shares.

In this too, like a bonus, the number of shares increases but the price and market capitalization of the investment does not change. A stock split is linked to the face value of the share.

For example, suppose the face value of the share is Rs 10 and the share is split in the ratio 1: 2, then the face value of the share will be Rs 5 and if you had one share, now you will have two shares. This table will make it clear to you.

Split Ratio	Old Face Value	Share Number Before Split	Share Price Before Split	Investment Price	New Face Value	After Split Share Number	After Split Share Price	Split Investment Price After Split
1:2	10	100	900	90,000	5	200	450	90,000
1:5	10	100	900	90,000	2	500	180	90,000

Like bonus issues, stock splits are also used to increase investor participation.

Rights issue

Companies use rights issues to raise capital. The only difference is that while a public issue brings in new investors, in a rights issue, money is raised from existing shareholders. In a way, you can consider it as a public issue brought to certain people (shareholders). The rights issue means that the company is going to do something new. Old shareholders can buy shares from the rights issue in proportion to the shares held by them. For example, a rights issue of 1:4 means that if you have 4 shares, you can buy one more share. One special thing is that in the rights issue, the shares are found below the market price.

However, investors should not only look at the discount on the share price. This is not a bonus share here you are paying for the share and that’s why you should invest the money only when you are satisfied with the future of the company.

One more thing, if the share price falls in the market before the rights issue and goes below the issue price of the rights issue, then it would be better to buy the share from the market.

Buyback of Shares

In a buyback, the company buys its own shares from the market. This can be seen as an investment in the company itself. Buyback reduces the number of shares of the company in the market. It is also considered a method of corporate reshuffling. There can be many other reasons for buyback.

1. increase profit per share
2. Increase promoter’s stake in the company
3. refrain from taking over someone else’s take over
4. Showing the promoter’s confidence in the company
5. stop the fall in the share price

 

The buyback shows the confidence of the company so its announcement drives up the share price.

Highlights of this chapter

1. The decisions of companies affect the share price.
2. Shareholders are rewarded through dividends, with dividends given as a percentage of the face value.
3. To get a dividend from a company, you must hold shares of the company before the X dividend date.
4. A bonus share is a kind of stock dividend. The company rewards its shareholders by giving more shares in the form of bonus shares.
5. In a stock split, the face value of the share changes so does the share price.
6. The company raises additional capital through a rights issue. In this, the existing shareholders of the company invest money. You should invest in the rights issue only when you are confident about the future of the company.
7. Buyback shows the confidence of the company and also the confidence of the promoter of the company.