Answer
# 1 |
When a publicly-traded company issues a corporate action,
it is initiating a process that will bring actual change to
its stock. By understanding these different types of
processes and their effects, an investor can have a clearer
picture of what a corporate action indicates about a
company's financial affairs and how that action will
influence the company's share price and performance. This
knowledge, in turn, will aid the investor in determining
whether to buy or sell the stock in question.
Corporate actions are typically agreed upon by a company's
board of directors and authorized by the shareholders. Some
examples are stock splits, dividends, mergers and
acquisitions, rights issues and spin offs. Let's take a
closer look at these different examples of corporate
actions.
Stock Splits
As the name implies, a stock split (also referred to as a
bonus share) divides each of the outstanding shares of a
company, thereby lowering the price per share - the market
will adjust the price on the day the action is implemented.
A stock split, however, is a non-event, meaning that it
does not affect a company's equity, or its market
capitalization. Only the number of shares outstanding
change, so a stock split does not directly change the value
or net assets of a company.
A company announcing a 2-for-1 (2:1) stock split, for
example, will distribute an additional share for every one
outstanding share, so the total shares outstanding will
double. If the company had 50 shares outstanding, it will
have 100 after the stock split. At the same time, because
the value of the company and its shares did not change, the
price per share will drop by half. So if the pre-split
price was $100 per share, the new price will be $50 per
share.
So why would a firm issue such an action? More often than
not, the board of directors will approve (and the
shareholders will authorize) a stock split in order to
increase the liquidity of the share on the market.
The result of the 2-for-1 stock split in our example above
is two-fold: (1) the drop in share price will make the
stock more attractive to a wider pool of investors, and (2)
the increase in available shares outstanding on the stock
exchange will make the stock more available to interested
buyers. So do keep in mind that the value of the company,
or its market capitalization (shares outstanding x market
price/share), does not change, but the greater liquidity
and higher demand on the share will typically drive the
share price up, thereby increasing the company's market
capitalization and value.
A split can also be referred to in percentage terms. Thus,
a 2 for 1 (2:1) split can also be termed a stock split of
100%. A 3 for 2 split (3:2) would be a 50% split, and so
on.
A reverse split might be implemented by a company that
would like to increase the price of its shares. If a $1
stock had a reverse split of 1 for 10 (1:10), holders would
have to trade in 10 of their old shares for one new one,
but the stock would increase from $1 to $10 per share
(retaining the same market capitalization). A company may
decide to use a reverse split to shed its status as
a "penny stock". Other times companies may use a reverse
split to drive out small investors.
Dividends
There are two types of dividends a company can issue: cash
and stock dividends. Typically only one or the other is
issued at a specific period of time (either quarterly, bi-
annually or yearly) but both may occur simultaneously. When
a dividend is declared and issued, the equity of a company
is affected because the distributable equity (retained
earnings and/or paid-in capital) is reduced. A cash
dividend is straightforward. For each share owned, a
certain amount of money is distributed to each shareholder.
Thus, if an investor owns 100 shares and the cash dividend
is $0.50 per share, the owner will receive $50 in total.
A stock dividend also comes from distributable equity but
in the form of stock instead of cash. A stock dividend of
10%, for example, means that for every 10 shares owned, the
shareholder receives an additional share. If the company
has 1,000,000 shares outstanding (common stock), the stock
dividend would increase the company's outstanding shares to
a total of 1,100,000. The increase in shares outstanding,
however, dilutes the earnings per share, so the stock price
would decrease.
The distribution of a cash dividend can signal to an
investor that the company has substantial retained earnings
from which the shareholders can directly benefit. By using
its retained capital or paid-in capital account, a company
is indicating that it can replace those funds in the
future. At the same time, however, when a growth stock
starts to issue dividends, the company may be changing: if
it was a rapidly growing company, a newly declared dividend
may indicate that the company has reached a stable level of
growth that it is sustainable into the future.
Rights Issues
A company implementing a rights issue is offering
additional and/or new shares but only to already existing
shareholders. The existing shareholders are given the right
to purchase or receive these shares before they are offered
to the public. A rights issue regularly takes place in the
form of a stock split, and can indicate that existing
shareholders are being offered a chance to take advantage
of a promising new development.
Mergers and Acquisitions :
A merger occurs when two or more companies combine into one
while all parties involved mutually agree to the terms of
the merge. The merge usually occurs when one company
surrenders its stock to the other. If a company undergoes a
merger, it may indicate to shareholders that the company
has confidence in its ability to take on more
responsibilities. On the other hand, a merger could also
indicate a shrinking industry in which smaller companies
are being combined with larger corporations. For more
information, see "What happens to the stock price of
companies that are merging together?"
In the case of an acquisition, however, a company seeks out
and buys a majority stake of a target company's shares; the
shares are not swapped or merged. Acquisitions can often be
friendly but also hostile, meaning that the acquired
company does not find it favorable that a majority of its
shares was bought by another entity.
A reverse merger can also occur. This happens when a
private company acquires an already publicly-listed company
(albeit one that is not successful). The private company in
essence turns into the publicly-traded company to gain
trading status without having to go through the tedious
process of the initial public offering.Thus, the private
company merges with the public company, which is usually a
shell at the time of the merger, and usually changes its
name and issues new shares.
Spin Offs :
A spin off occurs when an existing publicly-traded company
sells a part of its assets or distributes new shares in
order to create a newly independent company. Often the new
shares will be offered through a rights issue to existing
shareholders before they are offered to new investors (if
at all). Depending on the situation, a spin-off could be
indicative of a company ready to take on a new challenge or
one that is restructuring or refocusing the activities of
the main business.
Conclusion:
It is important for an investor to understand the various
types of corporate actions in order to get a clearer
picture of how a company's decisions affect the
shareholder. The type of action used can tell the investor
a lot about the company, and all actions will change the
stock itself one way or another
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