Know the impact of right issue on stock price; Investors need to be cautious while holding stocks offering massive right

Rights Issue is an issue of new shares for existing shareholders in proportion to their existing holdings. A rights issue is, therefore, a way of raising fresh capital from shareholders – this is an important source of new equity funding for companies. By taking these rights share, existing shareholders can maintain their existing percentage holding in the company. Currently in the market we can see a lot of companies are offering right to its existing shareholders. Generally, Right Shares are issued to increase the capital base of the company. The company needs further capital mainly for 3 reasons; firstly for business expansion, secondly for covering business risk (to cover up loss) and some time to follow regulatory body to increase the paid up capital. In FY 2072/73 Nepal Rastra Bank (NRB) through its monetary policy has directed all the BFI’s to increase their capital base by the end of FY 2074/75. Due to this many BFI’s are offering handsome right share to its existing shareholders for increasing its paid up capital. In 2015/16, more than 9.40 units right shares were issued by different bank and financial institutions. At present there are altogether 10.54 arba units right shares in pipeline of Securities Board of Nepal and 3.44 arba units of Right Share have been approved. As investors we need to analyze the effect of bombarding right shares on the future stock price.   WHAT’S NOT GREAT ABOUT A RIGHTS ISSUE? The right shares do not come free of cost. Investors need to buy the shares. For shareholders, the earnings per share will reduce since there are more shares for the same earnings, and so will be the dividends.  Whenever a company comes out with a rights issue you have to evaluate it to see whether it makes sense for you to subscribe to it. Subscribe to a rights issue only if you really trust in the company’s performance. Don’t just buy it because you are getting it in cheaper market price. Try to find out why the company is offering right share. If the company needs this to raise money for a sound business expansion that will eventually increase the profit in long run and share price, then it is good.   WHAT’S GREAT ABOUT A RIGHTS ISSUE? The best part of right issue is that the shares will be cheaper than the current market rate that means we can buy it at par value. Generally, when any rights issue is announced, the price will go up because investors now want to buy the shares so that they can avail of the rights issue. So the investors gets the benefit from the market due to its increased price but you need to make sure whether the extra share you purchase will make extra earning in long run or not. If the company is utilizing the extra capital generated through right issue then it will be wise decision to hold share but if you think company cannot utilize the increased capital then it is wise decision to sell share at increased price.   WHAT HAPPENS TO SHARE PRICES AFTER RIGHTS ISSUE? After the right issue is offered price of that particular stock falls in the stock market. It happens because the number of stock of that company increases in the market. Especially if the number of the right issue is relatively higher than the paid-up capital of the price falls. Moreover the dividend yield and the PE ratio of that particular stock also decline after the right issue is offered. Theoretically the right issue does not give significant profit to the shareholders despite of the fact that they get the stock in lower price. But in practice the shareholders always find the right issue an attractive option to buy the shares of the company. This is because investors presume that the company is going to utilize the additional fund from the right issue for further development and expansion of the company which will eventually strengthen the financial position of the company. Summing up, rights issue has following effects on the price of a stock:

1. Share capital gets increased according to the right issue ratio.
2. Effective Earnings per share, Book Value and other per share values reduces.
3. Market takes action usually as a favorable and timely act.
4. Market price gets adjusted (after book close) on issue of right shares.
5. Company gets better cash flow which may be used to improve the business and may help increase effective Earnings per share.

  CONCLUSION Choose to subscribe for a rights issue only if it’s right for you and do not subscribe just because it comes at a lower price. Many people are buying shares in the hope of getting right shares at the rising price but investors need to be cautious while holding the right shares.