An Introduction to Stock Trading Part 3 - Corporate Actions

For the third part of my Beginners Guide to the Stock Market I am going to speak about Corporate Actions.

Part 1 - A few Terms and Part 2 - Dividends can be found on these links.

 

A corporate action is an action taken by a publicly listed company that effects the share holding in some way, The most common type of Corporate Action is the Dividend as I spoke about earlier but in this section I am going to look at a few of the more common corporate actions that come up rarely but that you will see if you hold shares for any period of time - especially through a turbulent financial time.

Please note that all of these explanations are  generic and you should seek advice before making any decisions on your portfolio.

Rights Issue:

A rights issue is where a company looks to raise more capital from its shareholders and it does it buy issuing to those shareholders a "Right" to purchase more shares - normally at a reduced cost. These rights can be taken up by the shareholder in which case the %age of the company he owns is maintained, he may refuse his rights in which case the shares are sold on the market and the profit from the sale is given to the shareholder or the shareholder can sell some of the rights and use the proceeds to purchase the remainder of the shares (Called Swallowing Your tail.)

as an example if we consider a company where we hold 100 shares worth £1 each in a company. during a rights issue the company gives a rights ratio of 1:1 and a discount of 25% then their rights would be for 100 shares at 75p each. If he took the full rights then he would have 200 shares at an average cost of 88p if he sold the rights then they would be worth 25p each (Effectively the difference between the special purchase price - 75p - and the normal market value -£1) so he could sell all of his rights for £25 or "Swallow the tail" by selling 75 of the rights to purchase 25 of the new shares to give him 125 shares at an average cost of 80p but with a smaller % of the company.

Return of Value:

A return of value typically occurs when a company is able to release a lot money either through dispersal of assets, a planned for project that is no longer needed or simply to return reserves that had been built up.

The return of value could be in Cash or Shares depending in what way the company receives what it is holding. The actual return of value will normally follow the same process as a dividend payment and will normally be received the same way that you receive your dividends. If you receive shares as part of the return then there will often (but not always) be a trade facility offered to dispose of them at a reduced rate - depending on your broker and the size of the deal.

When there is a return of value to the shareholders the price of the share will normally increase by the amount to be returned when it is announced, in fact it is normally priced in before that as the market senses that something may happen, and the share price will drop by the amount of the return on the ex-div date.

Consolidation/Stock Splits:

A stock consolidation reduces the amount of shares in a company and a stock split increases them, essentially they are two sides of the same coin.

Stock Splits are done to increase the amount of shares in the market and typically take place after a share value increases rapidly, the share split is designed to make the market in the shares more liquid as it enables people to diverge part of their holdings and more buyers may be present for 10 shares at £10 than for 1 Share at £100. although a Split is often thought to encourage further price rises by making shares more trade able there is no net gain by the shareholder unless the share price continues to go up.

A consolidation goes the other way and takes  several shares and replaces them with one share of the combined cost. so if you had 10 shares at £1 each they may replace them for 1 share at £10. this is often as result of a very poor performing share so there is often a stigma to consolidating but it can also occur after corporate events for example if a company sells off a large asset it may lose half its value in which case by doing a stock consolidation they can maintain the share price.

for example, if you have 100 shares at £1 each and the company announces that you will get a return of value equal to 50p per share your shares will reduce in value by 50p to offset this the company may also complete a consolidation and therefore they will return to you 100 x 50p (£50) and at the same time complete a 2:1 consolidation so after the return of value you would have £50 and 50 shares at £1 there is no net difference to the shareholder (If there is money to be made it would be made before the action is announced)

Share Buy Back:

A buy back is an alternative to a dividend payment,The company uses its profits to purchase its own shares which it can then take out of distribution or hold for a time that it needs to reissue them.

A share buy back should return some value to shareholders as it will restrict the amount of shares available and should therefore push the share price higher, it is mostly used when the company believes that its shares are trading on a considerable discount.