Impact of Corporate Actions on Stock Prices
Last month, there was a flurry of activity in the USA Stock Market:
Tesla and Apple Inc. had split their respective shares. Just a week before, Apple had become a $2 Trillion company. And for the first time in a long time, Tesla dominated the news on their shares that have been rallying, which is refreshing compared to the news showcasing the latest of Elon Musk’s theatrics.
What does this term mean? Is it necessarily a good thing? How do the common folk benefit from this?
Imagine your favorite pizza that is cut into 8 slices. 2 for each of your 4-member family. If everyone’s ability to control themselves, that’s what they will get.
If you were to further cut those 8 slices into 2 slices each, there would be 16 slices. And everyone at home will be entitled to 4 slices each. There’s no change in the price, the shape, or the taste of the pizza, but the psychological feel will make one think that they have more pizza and therefore a more satisfying stomach.
This is essentially what Stock Splits are. The number of shares outstanding held by retail investors is divided as directed by the board of the company, resulting in more shares held by a particular investor and a fall in the share price; however, the market capitalization of the company does not change.
This is mainly done by a company in order to create a buzz for their company and incentivize smaller investors by making the shares more affordable in order to control a bubble created due to the constant buying pressure of a particular company’s stock that happened for a variety of reasons.
Apple’s stock went up to 7.5% just 2 days after the split, while Tesla went to a whopping 12.6% a day after the split took effect.
To reiterate it’s a great and effective way to create more demand for a company’s stock. However, the gains are quite momentary, and pessimism does eventually set into the market. The gains earned by the 2 companies, however large, were quickly eroded within a few weeks. Regardless, this is an effective way a company can control its share prices and bank on the market forces of demand and supply to take over.
Companies in India have also incorporated this technique to manipulate the prices in the stock market; most notably HDFC Bank split their shares in a 1:2 ratio, Eicher Motors split their shares in a 1:10 ratio and Bajaj Steel split their shares in a 1:2 ratio. The 3 companies saw a growth of 0.92%, 10%, and 1.26%.
Another way companies can manipulate and control their respective share price is through a share buyback. This is however a double-edged sword because companies can either do it as a response to a good situation or a bad situation.
In a good situation, a company can buy back their shares with the excess cash they are generating in their business to reduce the number of outstanding shares in the open market, and again create a buzz to help further rally its share price. It is seen as a signal of corporate health and results not only in improved shareholder value, but also bolsters up the share price of the company in the short term.
Companies like Apple that are flush with cash have repurchased their shares and on the domestic turf, last year Infosys had bought back shares aggregating to Rs 8,260 crores which resulted in a 4% gain in just a day or two.
However, companies may buy back their shares to superficially boost earnings. This may tempt investors, but the company may have weak financials or restricted cash flows. But the artificial demand created by the buyback usually distracts the typical retail investor. A company may also want to buy back its shares to regain control that has been diluted through poor planning of offers to stakeholders and other investors.
A metric that amateur investors use is EPS = earnings/no. of outstanding shares. A higher number is favorable to the company. However, if the no of outstanding shares reduces, the number will go up without it necessarily meaning that the earnings are growing in parallel, which is quite misleading.
There is a tax advantage to buyback of shares, up until last year there was a 20% tax levied on buyback of shares. However, the center has scrapped any tax that would have to be paid on any capital tax arising from any purchase of shares through a buyback scheme in order to rejuvenate the cash circulation in the economy, which has led to companies like Wipro and Infosys hitching onto this move.
These are a few ways companies can use to control the market forces of demand and supply to benefit their objective.
Written by Rohann