Action on the bourse

Dalal Street has to keep its eyes and ears open for all announcements and news on inflation, crude oil prices and interest rate changes because they have a direct bearing on share prices. There is, however, another price-sensitive information that is keenly monitored by traders, investment experts, fund managers and retail investors. These are the “corporate actions” announced by companies regarding their equity.

Corporate actions, especially bonus and buyback announcements, can cause a sudden change in the price of a share. After the initial spurt due to speculative activity comes the real impact when the proposal is implemented. As an investor, you should know what the different corporate actions signify, what the tax implications are, how they can affect your returns and the information you should have to derive the maximum benefit from the changes in a company’s equity.

Bonus shares

CORPORATE ACTION TERMINOLOGY Record date or book closure: The cut-off date fixed by a company to determine who is eligible. You get the benefit only if you have shares in your demat account by this date. Ex date: The date on which the share price is adjusted for the corporate action on the stock exchange. Bonus and dividend stripping: Short-term losses after a bonus or dividend are not allowed by the taxman if the shares were bought less than three months before or sold less than three months after the issuance. First in, first out: What you buy first gets sold first. So, if you get bonus shares and sell some of your holdings, the original shares will be deemed to have been sold first. Information update: Websites of both the NSE and the BSE mention the corporate actions announced by a company.

If a company is doing well and its coffers are overflowing, it often rewards its shareholders with free—or bonus—shares. If a bonus of 1:2 has been announced, it means a shareholder will get one share for every two held by him. The issuance of these bonus shares increases the company’s equity capital as well as the number of shares. A part of the cash reserves are transferred to the equity capital of the company.

Such a move is indicative of the good prospects of a company. It shows that the management is confident of serving a large equity base in the coming years. That, and the lure of short-term gains, sends the share price shooting up after a bonus announcement. The price remains buoyant till the deadline (or ex-bonus date) set by the exchange. This is two days before the record date decided by the company to determine who is eligible for the bonus shares.

After the ex date, the price corrects to adjust for the bonus shares. Theoretically, the price should fall in proportion to the bonus ratio. But, in most cases, the market-adjusted price is at a premium to this price.

For tax purposes, the cost of the bonus shares is taken as zero and the ex-bonus date fixed by the company is considered the date of acquisition. If these shares are sold within a year, there is a 15% short-term capital gain tax on the proceeds. However, if the shares are kept for more than a year, there is no tax.

Rights issueWhen a company offers additional shares to its shareholders, it is called a rights issue. Companies do this to raise capital for funding expansion plans or acquisitions. Hindalco Industries, for instance, came out with a 3:7 rights offer (three share for every seven held) to raise nearly Rs 5,000 crore to finance its acquisition of Novelis. But these shares are not issued free of cost. The existing shareholders are given the right to purchase shares, usually at a discount to the prevailing market price, to make the offer attractive.

In a bull market, the announcement of a rights issue usually boosts the price of a share because investors get to purchase more shares at a discounted price. But in bear markets, such offers may not make a difference. In case of JK Tyres (see chart), the price actually fell. A rights issue is treated like any other purchase by the taxman. The date of allotment of rights shares is considered for determining whether such a sale attracts the 15% short-term capital gain tax.

Dividends
A dividend is a payment made to every shareholder of the company from its profits. It can be announced with any of the quarterly results. The dividends received by shareholders are tax-free. The dividend announced is linked to the face value of the company’s share. If the share has a face value of Rs 10 and the company announces a 50% dividend, the shareholders will get Rs 5 for every share that they hold. If the face value is Re 1, then a 200% dividend would translate to a payout of Rs 2 per share. While there is no limit on the number or quantum of dividends, there is no obligation on the part of the company to pay the dividend.

Buyback offers

If a company wants to delist its shares or the promoter simply wants to increase his stake, they offer to buy them back from the shareholders. The offer is usually at a significant premium to the existing market price to make it attractive to the shareholders. Buybacks cause the shares to shoot up temporarily.

But buyback offers can be tricky if you are entering at the wrong time. If a company plans to buy only 25% of the equity, it will reject applications once it has bought the required number of shares. So, an investor who bought the shares hoping to sell them to the company at a higher price, may end up seeing the value of his shares drop after the buyback offer closes.

If an investor sells his shares back to the promoter, the transaction is not routed through a stock exchange and no securities transaction tax is paid on it. Therefore, the investor is not eligible for the exemption available to equity investors who buy shares through a stock exchange. The short-term capital gain will be added to the income of the investor, while the longterm capital gain will be taxed at a flat 10% or 20% after indexation. The investor can opt for any one of these methods.

Mergers and acquisitions

Sometimes, two companies merge in order to gain from the possible mutual synergies. Mergers are generally perceived as a positive signal. In May, the market was abuzz with rumours of a possible takeover of Spice Communication. As a result, its share price shot up from about Rs 35 in April to about Rs 75 when it was finally taken over by Idea Cellular . If a company’s stake in another entity touches 15%, it has to make an open offer for an additional 20% of the stake. This ensures that small investors are not left out.

Stock splits

If the price of a share becomes too high, its liquidity on the stock market goes down. To improve the liquidity, companies often split their shares into smaller denominations. This reduces the face value of the share and there is a corresponding change in its market value. A share with a face value of Rs 10 is split into five shares with a face value of Rs 2 each. If the share priced at Rs 360 is split into five, the new price should theoretically be Rs 72. However, stock splits inject more liquidity into a share, thus making it attractive. So the postsplit price could well be close to Rs 75-80.

A stock split is just an arithmetical exercise. The asset side of the balance sheet and the net worth of the company remain unchanged. The share capital of the company too remains unaffected. The taxman considers the date of buying the original shares as the date of acquisition. The gains from the shares are taxed in the same proportion as the split.