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Corporate Actions: Playing on the minds...

Sep 7, 2004

The share price traces a company's earnings potential and long-term growth. However, in the short term, there are many factors that outweigh long-term fundamentals. These factors could be 'tips', economic news resulting in over-optimism and last but not the least, corporate actions. It is therefore said that a retail investor should do what the promoter of the company is doing.

Let us now look at the various indications that corporate actions give to a common investor:

  • Share buy-backs (Do what the promoters do?):  Recently, on 9th June 2004, Reliance Energy came up with a buyback offer at a share price of Rs 525 each. Usually, buyback programs are an indication of the fact that the current market price is perceived to be cheap by the company. As a result, it would make economic sense for the promoters to up their stake in the company. Buyback is also a value creation exercise for shareholders. Not only does the buyback price become a 'base' price at times, it also gives an attractive exit option for the shareholders.

  • Promoters' stake sale:  This is exactly the opposite of the first case. In FY04, stock witnessed record high levels, led by mid-cap stocks and at this juncture, promoters of the company were selling off their stake, either through open offers or through private placements. Most of the times, promoters' stake sale is considered to be a negative for the stock, as it indicates that the management wants to 'cash-in' on high prices, which they do not think are justified. Secondly, it also indicates the confidence of the management. The promoter can either sell a part of the existing shares or place a new lot with some investors that automatically result in promoter stake dilution. In case of issue of new shares, investors should understand what the company plans to do with the money that was raised? If it is for new investments or funding existing businesses, it is good. Otherwise, it only dilutes earnings per share.

  • The dividend controversy:  It is the basic aim of any corporate entity to reward its shareholders either by way of capital appreciation or by way of rich dividends. As a retail investor, it is important to note the growth stage of the company in which you remain invested. In case of a high growth or an expansionary phase, the company would have a very high retention ratio (i.e. retain a large part of net profit for more investment in existing business) and therefore would pay out less by way of dividends. There is nothing wrong in declaring low dividends if the management feels that it could generate more profitably by investing in assets. While on the other hand, in a stable growth stage, the company need not retain a large portion and the payout ratio could be larger (take the case of Hindustan Lever in the last four years). It is advisable to look at the annual reports of the company to understand the management's outlook on the existing business and its investment plans. If the company does not have significant investment plans, as a shareholder, you have every right to question the management in case dividends are lower.

  • Quarterly announcements:  As per the Securities and Exchange Board of India (SEBI) guidelines, the listed entities have to declare results on a quarterly basis. It is perceived that the results may not be too encouraging when the declaration is expected on Friday, i.e., the 'Friday effect'. From a long-term investors perspective, too much emphasis on quarterly performance is not the right way to judge the management's ability. Some businesses are seasonal and some projects may take time to gain economies of scale and so on. Quarterly results only enable an investor to judge whether the company is moving in the right direction or not.

  • Analyst meets:  Other typical corporate actions are analyst meets and broker conferences (wherein top institutional investors gather at one place and the company presents its growth strategy, which is typically organized by a broker/merchant banker). While these are restricted to a few set of investing public, we believe that there is also a case for retail investor conference as well. Why should the management give too much importance to institutional investors and not the shareholder (though annual general meetings are held once in a year)? Most of the top corporates put up the analyst presentations on their website, which a retail investor should access to keep himself updated.

As per the SEBI regulation, a corporate is supposed to disseminate price sensitive information to the exchange at the same time. Though SEBI has been making significant efforts to improve the disclosure norms, there has to be overall effort from the corporate side as well. Sometimes, this has been found wanting. The objective of this article is to once more highlight the need for the retail investor to keep abreast with the news flow that is emanating from the company.

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