Get Stocks at Discount with the Right Issue

What if I tell you that you can buy your favourite stock at a 10%, 20%, or even 30% discount? Hard to believe, right? But there’s a catch: you need to be an existing shareholder of that company. Can you guess what I’m talking about? Yes, you got it—I'm talking about the "Rights Issue." But before discussing whether you should invest in it or not, let’s first understand what a Rights Issue is.

A Rights Issue is an invitation to existing shareholders to buy additional new shares of that company. To make this offer more attractive, the company issues these shares at a price lower than the market rate. The company can then use this extra capital for purposes like debt repayment or business expansion.

Now that you understand what a Rights Issue is, let's discuss how it works. First, the company will announce the Rights Issue in a specific ratio. This ratio could be 1:10, 1:15, or 1:5—there’s no fixed number. In simple terms, if the company decides on a 1:10 ratio, it means that if you own 10 shares, you will receive one additional share, making your total 11. And if you’re eligible for the Rights Issue but don’t have the funds, don’t worry; the company doesn't require full payment all at once. They will collect funds in instalments. The first instalment is known as the “First Call,” and the remaining amount will be collected over two instalments.

But should we buy every discounted offer? What if you don’t want to apply for the Rights Issue? Let me explain. In 2020, a concept known as "Rights Entitlement" emerged, which allows shareholders who don’t wish to apply for the Rights Issue to trade these rights as tokens in the secondary market. This concept benefits both buyers and sellers—buyers get shares at a discounted price, and sellers receive payment for their rights.

So, where can we trade these tokens? You can trade them on equity market trading platforms, just like any other equity.

Let’s now clear up the common confusion between a Rights Issue and a Bonus Issue. The key difference is that in a Rights Issue, a shareholder has to manually exercise their rights, while in a Bonus or Split, the process is automatic. Participation in a Rights Issue is optional; you can apply if you wish, but it’s not mandatory. On the other hand, in Bonus and Split shares, participation is mandatory for all shareholders.

So far, we’ve discussed the generic aspects of a Rights Issue, but does it offer any specific benefits for you or even for the company you own? For the company, it provides additional capital flow, helping to meet current financial obligations. For investors, they can buy stocks at a discount, and it increases their stake in the company. However, just as there are advantages, there are also disadvantages. When the number of shares increases, the company's Earnings per Share (EPS) decreases. And if too many shareholders decline the Rights Issue, the dilution of existing shareholders' stake may increase as new investors come in.

So, should you apply for a Rights Issue? The answer depends on the reason why company is providing Rights Issue in the first place. If a company has a significant debt and issues a Rights Issue, you might just be buying into their debt. However, if a company with little or no debt offers a Rights Issue for business expansion, it may be worth considering.