(2) Effects of Corporate actions on Stock prices: Part II

This is part II of the article Effects of Corporate actions on Stock prices . Please start reading this article from the beginning, before proceeding with this part.

There are several other types of corporate actions: Rights issue, spin-offs, mergers, acquisitions, share buy-back, etc.

An important question is: whether these corporate actions create any value for the company?

Theory says there is no benefit of CA; Practical cases refute the theory.

As per the theory, (Miller Modgiliani postulate), there is no value created by corporate actions or corporate restructuring. The reason is that the net value of the company remains the same. For e.g. as I’ve quoted in my previous article, about news based trading, Around 2-3 years back, Balaji Telefims (The Saas-Bahu serial TV Company led by Ekta Kapoor), was trading at Rs. 105. It declared a dividend of 16 Rs. a share. Within 1-1.5 minutes the price of the stock reached 121-122 Rs. I acted on this news an hour later and purchased the shares at 122 Rs. After the dividend expiry, the price fell back to 102-103 levels (later even to 85 Rs.). I got the dividend, but I got nothing better than the market price, instead I paid more than the market price after the ex-dividend date.

However, due to the dividend declaration, there was some price change in the market. So practically, there is some effect of corporate actions on the stock prices and valuations.

Lets take the case of a stock split. A colleague of mine acted on a stock split news of a penny stock: IQMS Software. The stock was trading at around 8 Rs. when the news of 1:10 stock split came in. Immediately, the price started to increase and touched a high of 13 Rs. My friend bought this stock in big numbers at 11 Rs. After the stock split, the price had changed by a factor of 10, i.e. his buy price of 11 Rs. was now Rs. 1.10 and the no. of stocks he bought was multiplied by 10 times. He invested a total of around 1.5 Lakh Rs. for purchasing this stock. However, after the split, the stock price started to decline, touched a low of 0.36 Rs. and as of today, it is 0.75 Rs. My friend is waiting since last 2 years just to recover his money. The stock has never made to his buy price of 1.1 Rs.

Even though the prices fell back to as low as 0.36, there were changes in the initial levels – from 8 Rs. to 13 Rs. People who managed to book profits were happy, those who couldn’t, are still waiting (like my colleague).

However, in practice, due to corporate restructuring actions, there is obviously some change. For the case of stock split, the change is in the form of more liquidity being induced in trading. Hence, the prices show an upward trend. Whether one can capitalize upon that change and how much he can gain, is still a question that leads to high level of uncertainty. The MARKETS ARE EFFICIENT –hence, everything is reflected immediately in the price. One may be lucky enough to get a piece of cake, just by chance. How long will that piece grow, no one knows. When it will start contracting, no one knows. Stock splits of companies like Reliance or Mahindra have proved to be positive in the near past, though there have been instances where rights issues of companies like Ballarpur Industries have failed and resulted in value decrease.

In practical essence, corporate actions do add some value to your holdings. The value may be positive or negative. It may be in terms of liquidity being induced, or due to a part capitalization of your holdings (like paying a dividend). Whether you want to act on any such news or keep away, is your choice.

This article was to introduce corporate actions and how it affects the market prices.
In the next article, I’ll give examples of how companies make a fool of investors by taking advantages of the corporate actions and improve their balance sheet figures. Please visit this blog tomorrow as well.

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You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.