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So you’re ready to get started investing your money – awesome! Investing is a key part of building your wealth and planning for the future.
As you head out on your investment journey, one of the important factors you’ll want to keep in mind is corporate actions.
For starters, what is a corporate action, right? With a publicly-traded company, decisions about the company’s stock, brand, and assets are made by a board of directors.
Decisions that materially impact the company and its stockholders (you!) are known as corporate actions.
But how exactly will a corporate action impact your particular investment? Well, it depends on what type of corporate action it is.
Generally, corporate actions belong under one of two categories: mandatory and voluntary.
Mandatory corporate actions are put into place by the board of directors without any say from the stockholders.
Voluntary corporate actions, on the other hand, require a response from stockholders before they can be carried out.
Below, we’ve outlined four common types of corporate actions and how each one can affect your investment.
A dividend is a corporate action determined by the company’s board that distributes some of the company’s earnings (profits) to shareholders of common and preferred stock.
The dividend payout can be issued in new shares or cash dividends and you can either reinvest them to grow and compound for the future or live on them in retirement.
We love our dividends around here and this corporate action is the basis of our Infinite Income retirement planning and investing strategy.
A stock split is essentially just what it sounds like. A company takes all outstanding shares and divides them, usually into two or three shares, adjusting the price to keep the original value the same.
There are two different types of stock splits: forward and reverse.
So, if you had one share in a company that performed a 2-for-1 forward split, you would then own two shares, each worth half the value of the original. Like Christmas came early, you receive a bonus share without paying any extra money!
Forward stock splits allow companies to make their shares more affordable without altering the value of the company itself. The impact on shareholders for this type of corporate action is entirely positive. You’ll receive extra shares in the company and likely see some growth in stock prices at the same time – sweet deal!
A reverse stock split is the opposite. In this case, the company’s board decides to reduce the total number of shares existing shareholders own.
So, if you had two shares in a company that performed a 1-for-2 reverse split, you would then own one share, worth twice the value of the original.
When this happens, it’s not a good sign for the company’s shareholders.
It usually means that the company’s share price has dropping significantly and they are in danger of being delisted from the stock exchange.
So they perform a reverse split to bump up that share price in what’s considered a desperate measure to stay in the game.
Mergers and Acquisitions
When two companies combine into one larger company, it’s known as a merger. In this case, one of the companies will often surrender all of its stock to the other.
Acquisitions, on the other hand, involve simply buying out more than 50% of another company’s stock without merging the two entities at all.
However, if Company A purchases a majority stake in Company B, then Company A will be able to make decisions for Company B without needing approval from its shareholders.
Mergers and acquisitions are both performed with similar goals in mind: expanding the company’s reach or increasing its portion of total sales in the industry.
Either way, you can usually view these sorts of company actions as a long-term win for you and your stocks.
Depending on the circumstances of the action, you may see a drop in share values at first.
But in the end, stock prices for a newly-formed company will come to exceed those of the prior two companies.
A spinoff is when a company announces the creation of an independent company by distributing new shares of an existing business or division of a parent company.
When a public company spins off a business unit that has its own management structure, it sets it up a brand new public company with a brand new trading symbol.
In this corporate action, the parent company’s shareholders typically get free shares of the new company or, at the very least, a discount on the share price of the new company.
And there you have it!
Now you’re ready to add some fancy new investor’s lingo to your vocabulary and continue your journey to retirement with confidence.