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8 Things You Should Understand About a Rights Issue of Shares

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Published Date: 10 Feb 2020Updated Date: 30 Dec 20246 mins readBy MOFSL

Today’s Stock Market: A World of Opportunities

Today, the stock market offers investors ample opportunity to make good gains. Experienced investors often advise young new investors to buy a solid stock and stick with it, not for months, but years, to see real rewards. Investing in stocks goes beyond just buying low and selling high. It involves understanding dividends, rights issues, and more. Let’s explore these concepts in detail.

Know the Difference

Recently, there has been a boom in the subscription of IPOs, or Initial Public Offerings. This is when a private company goes public, offering its shares for the first time to the general public. However, this is not a rights issue. A rights issue is an offer of additional shares to existing shareholders, unlike an IPO. Investors often subscribe to IPOs with an optimistic outlook on the company’s future. Conversely, a rights issue allows shareholders to purchase more shares at a discounted price.

Something About a Right Issue of Shares

When you purchase a stock, future announcements like a rights issue may affect your investment. A rights issue gives existing shareholders the option to buy additional shares at a discounted price. This can be advantageous if the company’s future prospects look positive. However, it’s essential to assess whether purchasing more shares aligns with your investment goals.

What is a Rights Issue?

For example, a rights issue in a 1:3 ratio means you can buy one share for every three shares you hold. If you own 300 shares, you’re eligible to buy 100 shares at a price set by the company. While a rights issue raises fresh capital, it also dilutes the equity, potentially lowering metrics like EPS (Earnings Per Share).

Here’s a breakdown of how equity dilution works:

Details

Pre Rights Issue

Post Rights Issue

Number of Shares O/S

10,000 shares

15,000 shares

Net Profits

Rs. 3,70,000

Rs. 3,70,000

EPS

Rs. 37 per share

Rs. 24.67 per share

Rights Issue

1:2

 

As shown, equity dilution occurs, affecting the EPS. It’s vital to consider this before participating in a rights issue.

8 Things to Be Aware of a Rights Issue - Understanding Rights Issue Meaning​​​​​​​

1. Definition - A rights issue is a fresh offer of additional shares to existing shareholders at a discounted price. It’s different from an IPO, which targets the general public for the first time.

2. Dilution of Equity - When a company issues new shares, the equity gets diluted, reducing metrics like Earnings Per Share (EPS) and Return on Equity (ROE).

3. Eligibility Criteria - Only shareholders on the company’s register by the record date are eligible to participate. The record date is followed by the ex-rights date, determining the eligibility timeline.

4. Subscription Options - Shareholders have the choice to subscribe to, ignore, or sell their rights in the market. Subscribing requires paying for the shares at the rights price.

5. Value of Rights - The value of rights is the difference between the market price and the rights issue price. This represents the benefit offered to shareholders.

Example:

Particulars

Amount

Market Price Before Rights

Rs. 180 (A)

Rights Issue Price

Rs. 100

Rights Ratio

1:2

Value of Investment (Pre-rights)

Rs. 1,80,000

New Cost of Shares

Rs. 153.33 (B)

Value of Right

Rs. 26.67 per share

6. Tradability - Rights can be traded on the stock exchange under a unique ISIN number. Shareholders can sell their rights if they choose not to subscribe.

7. Difference from Bonus Issues - In a bonus issue, shareholders receive additional shares for free, and the EPS remains unchanged. Rights issues, however, require payment for additional shares, albeit at a discounted rate.

8. Premium Pricing - Rights issues are typically priced at a premium over the stock’s par value but discounted relative to its market price, making them attractive to shareholders.

The Key Consequences of Right Issue of Shares

A rights issue enables companies to raise capital, often for expansion, debt reduction, or acquisitions. While it can signal growth, it’s crucial to analyse the reasons behind the rights issue to determine its impact on your investment.​​​​​​​

Benefits for Companies

  • Capital Raising: Companies can raise funds without incurring debt.
  • Growth Opportunities: Rights issues often finance acquisitions, R&D, or infrastructure expansion.
  • Debt Reduction: Funds raised can be used to pay off existing liabilities, improving the balance sheet.

Benefits for Shareholders

  • Discounted Shares: Shareholders can buy additional shares at a price lower than the market rate.
  • Increased Holdings: Rights issues provide an opportunity to increase equity in a company with growth potential.
  • Liquidity Options: Shareholders can sell their rights in the market if they choose not to subscribe.

Looking at Rights Issues Positively

Rights issues are not necessarily a sign of financial trouble. They can indicate a company’s plans for expansion, acquisitions, or debt restructuring. For investors, this can be an opportunity to strengthen their portfolio by acquiring more shares at a discount, especially in companies with strong fundamentals.

 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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