Corporate actions can be described as the small print of owning equities. Seemingly complex, many equity investors tend to dismiss them. But they can have a material impact (positive or negative) on the share price of a company, as well as giving investors a window into its strategy and financial health.
By Wendy Myers, head of securities at PSG Wealth
So, it’s extremely important for investors to keep up with the corporate actions impacting their portfolio – and then to act accordingly.
Types of corporate actions and what they mean for a portfolio
Corporate actions can either be voluntary, where the investor can choose to participate, or mandatory, where participation is obligatory because you are a shareholder. They allow investors to interpret whether a company is in a strong financial position and what its prospects are for the near term.
- Cash dividends – Simply put, cash dividends are a share of the company’s profits which are distributed back to shareholders. They give a strong reflection of the company’s financial health and are generally seen as very positive for a portfolio. However, investors must be aware of the timing of the cash coming in and have a plan for how it’s going to be invested. In a rising market, if you keep the cash and don’t act on it, you’re earning interest, but it doesn’t add real capital growth to your performance because of inflation.
- Stock Splits – A stock split, sometimes called a bonus share, divides the value of a company’s outstanding shares. While this may sound counterintuitive, it is regarded very positively for a share portfolio. The value of the share price effectively decreases because there are more shares in issue. This makes it more affordable for the retail investor, and that’s generally a very good outcome for the share because more people can invest. There is also increased liquidity, which generally assists in driving the price up, benefiting your portfolio. We’ve seen lots of examples of this offshore in the technology sector for those shares that have had excellent runs, such as Google, Amazon, and in the last couple of years, Nvidia.
- Spin-off – A spin-off occurs when a listed company divests – sells off – part of its assets and investors will own the newly spun off assets or company. We saw an example of this on our local exchange, where Transaction Capital spun off We Buy Cars. The positive We Buy Cars performance has benefitted shareholders who retained their investment – a classic example where a spin-off really does work for the investor.
- Rights issues – Rights issues can be positive or negative and generally occur when the company asks for further capital from shareholders. This can be positive if the capital raised is used for strategic growth initiatives, but if the company is using it to cover losses, it can be a red flag for investors.
- Mergers and Acquisitions (M&A) – M&A actions tend to be complex and can result in negative and positive investor outcomes. In-depth research is key to understanding the motivations behind the deal. A positive deal could result in increased market share and higher profitability for the combined entity. But ultimately, the shareholder needs to assess whether the action will retain the ethos of the company or dilute it.
- Reverse stock splits – Reverse stock splits are probably the biggest warning sign that a company you’re invested in is in financial distress. This action often leads to a lower stock price, so investors should keep an eye on any announcement of a planned reverse stock split.
How much weight should investors place on leadership changes
While not strictly a corporate action, leadership changes have the power to boost shareholder confidence or to wipe billions from the share price overnight. It is the most critical event that shareholders need to pay close attention to.
Changes at a leadership level have a massive, and long-term impact on the company’s ability to deliver on its strategic objectives. Fundamentally, the CEO not only delivers on a strategy – he drives the culture and is able to attract top talent.
When a change is announced, investors would be well served to read up about the incoming CEO to get a sense of the reason for the change, as well as their ability to deliver before making any portfolio changes. Markets tend to overreact to news of leadership changes, which could turn out to be benign or positive in the long run.
Stay informed
Being invested in equities is a lot of hard work. To avoid knee-jerk reactions to corporate actions and headlines, equity investors need to constantly stay up to speed on company news, financial results and potential events. Understanding the possible implications of these and reflecting on whether the changes still align with your risk tolerance and objectives is key.
Lastly, when you buy a share, it should be for the long term. You should be invested as an active participant in each company – using your shareholder status to influence actions where possible instead of being a receptacle of dividends.
If this feels overwhelming, a financial adviser can be a valuable ally to help guide you through the implications of corporate actions and the potential impacts on your share portfolio.