Know your rights

In the first of a series on the basics of stock market investments, John Andrew explains how rights issues work

Is it an offer too good to be true? You have shares in a company and you are offered more at a discounted price. In stock market parlance this is a rights issue. However, it does not necessarily mean that you are being offered a bargain.

Rights issues are an exclusive share offer to existing shareholders, with new shares being offered in a fixed proportion to current holdings - for example, one new share for each 10 currently held. However, why offer the share at a discount to the current market price?

Imagine that a company with shares currently trading at pounds 5 wants to raise pounds 10m. It could issue two million shares at pounds 5; or four million at pounds 2.50 and so on and fulfil its objective with each combination.

It is unlikely that a company would wish to offer new shares at the current market price. This is because it would want a "safety net" against a general decline in the stock market, or against its own shares weakening after the announcement.

Whatever the level of discount, providing all other factors remain unaltered, the value of an investor's holding after the rights have been taken up will theoretically equal the value of the shares before the issue, added to the cash paid to buy the new shares. This is because after the issue, the shares will settle at a level which is proportional to the amount at which the new shares were issued.

Sounds complicated, but an example can make it clear.

Suppose an investor has 1,000 shares which before a rights issue trade at pounds 5 each. If the company has a one-for-five rights issue at pounds 4, the investor may purchase 200 new shares for pounds 800.

After taking up the rights the shareholder will have 1,200 shares. Theoretically this will be worth pounds 5,800 (pounds 5,000, the pre-rights value, plus the pounds 800 cost of the new issue). This means that after the rights, providing nothing else has altered, each share will be worth pounds 4.83 (pounds 5,800=1,200 shares).

If a shareholder is theoretically no better off after a rights issue, it is tempting to ask why anyone bothers taking up rights. Of course in reality, if a company puts the money to good use, it will increase the value of its business and the value of its shares and dividends paid will eventually rise.

"Investors should examine why a company is raising new capital," says Michael Savoury, of Midland Stockbrokers. "Some need it to finance sound business expansion, while others are simply paying off old debts and could fail if the money is not forthcoming. Shareholders should therefore not assume that all rights issues are worth taking up."

So how do you know if a rights issue is worthwhile? The company will advise shareholders why it wants to raise capital. It will also send an allotment letter giving the terms of the offer. Every situation has to be assessed on its merits and your cash flow. Comment will appear in the financial press and you can also consult your financial adviser. If the issue is well received, the rights will have a value. The choices open to you are:

Take up all the rights. Simply return the allotment letter, duly completed, with your cheque, by the deadline;

Sell all the rights through a stockbroker. Remember, a commission will be charged. If your holding is small, this may not be an economical proposition;

If you do nothing, or miss the deadline, the company will sell the rights to which you are entitled and send you the net proceeds. The advantage of this route is that your share of the selling costs will be minimal, but the sale may not be at the most favourable time;

Take up part of the rights and use the proceeds of the remaining to fund the transaction.

When one of the companies in which you have shares has a rights issue, the most important thing to remember is that "discount" is not synonymous with "bargain"n

Start your day with The Independent, sign up for daily news emails
Have you tried new the Independent Digital Edition apps?
Finacial products from our partners
Property search

Have you won one of the £1m Premium Bonds' jackpots?

Video: The Independent's Personal Finance Editor runs you through the key facts about Premium Bonds

Give me the money: but not all providers are ready for transfers to Junior Isas

Parents will be able to switch dormant child trust funds to more competitive Junior Isa

Millions of dormant junior savings accounts were yesterday given the go-ahead to swap to better deals as the Government agreed to allow switching. Samantha Downes reports
Hard labour: a woman bears the load in a factory. But equal treatment is causing pension problems

Women to lose benefits from contracted-out pension scheme

Workers were promised that the state would pay inflation increases on parts of their pensions. But now the DWP disagrees
The Budget, says one critic, should have done more to encourage construction of affordable homes

Help for buyers but where are the homes?

A vote-winning Budget promised less tax, greater savings flexibility, and government handouts for first-time housebuyers
'It will be no wonder if people lack the enthusiasm to save taxfree,' says one expert. But there are ways to beat low rates on cash Isas

How to make the most of Isas: You can save more money now, the returns are tax-free and the rules are flexible

Rob Griffin sees how you can surmount the one big obstacle

Growing number of women under the age of 35 are turning to online gambling

Online gaming is changing the profile of victims, who see it as an answer to difficult relationships but sink deeper into trouble

Ethical investments: Lack of awareness means investors are supporting industries they oppose

Many of us have good intentions now but either we don't switch accounts or we back 'nasty' activities without realising
Payday lenders fail to recognise customers in financial difficulty, the FCA said

Payday lenders accused of unfair practices by watchdog

The Financial Conduct Authority found non-compliance in all reviewed firms

Hooray, you're going to live longer! But what should you do to celebrate?

Pension expert John Lawson talks on why improved longevity is something to plan for carefully

Pension freedom: Steve Webb answers your questions on the big shake-up

The new freedoms arrive in April but many of you have told us that you see problems as well as opportunities. The pensions minister Steve Webb responds
Pension Minister Steve Webb

There are 'dark corners' of the investment and pensions industry, says Pensions Minister

The DWP and the FCA have joined forces to investigate transaction charges in occupational pension schemes

Scottish Power was found to have unacceptably long call waiting times

Scottish Power hit with sales ban by regulator

The company was found to have unacceptably long call waiting times

This phoenix rose from the stage at the London Olympics. The insurer grew out of zombie life insurance funds

Phoenix Life: Chance of a refund for overcharged policyholders has risen

A retired adviser got his money back from the insurer after claiming he had been overcharged. Thousands of others may have a strong case
Expect a new wave of fishing expeditions by fraudsters now we can invest our life savings

Cold callers and your pension: watch out for dangerous boiler room scams

Sean O'Grady received a cold call last week that was much more sinister than normal. Yes, someone wants to get their hands on his pension...

Fuel poverty could claim 100,000 lives over next 15 years, warns energy charity

The NHS is currently bearing a yearly burden of approximately £1.5bn treating cold-related illnesses every winter

  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: Graduate Recruitment Resourcer

    £20000 per annum + commission: SThree: Sthree have an exciting opportunity for...

    Recruitment Genius: Telesales Executive - OTE £32,000+

    £18000 - £32000 per annum: Recruitment Genius: A Telesales Executive is requir...

    Ashdown Group: Marketing Manager - B2B, Corporate - City, London

    £45000 - £50000 per annum + benefits : Ashdown Group: A highly successful, glo...

    Neil Pavier: Commercial Analyst

    £50,000 - £55,000: Neil Pavier: Are you a professionally qualified commercial ...

    Day In a Page

    War with Isis: Iraq declares victory in the battle for Tikrit - but militants make make ominous advances in neighbouring Syria's capital

    War with Isis

    Iraq declares victory in the battle for Tikrit - but militants make make ominous advances in neighbouring Syria
    Scientists develop mechanical spring-loaded leg brace to improve walking

    A spring in your step?

    Scientists develop mechanical leg brace to help take a load off
    Peter Ackroyd on Alfred Hitchcock: How London shaped the director's art and obsessions

    Peter Ackroyd on Alfred Hitchcock

    Ackroyd has devoted his literary career to chronicling the capital and its characters. He tells John Walsh why he chose the master of suspense as his latest subject
    Ryan Reynolds interview: The actor is branching out with Nazi art-theft drama Woman in Gold

    Ryan Reynolds branches out in Woman in Gold

    For every box-office smash in Ryan Reynolds' Hollywood career, there's always been a misconceived let-down. It's time for a rethink and a reboot, the actor tells James Mottram
    Why Robin Williams safeguarded himself against a morbid trend in advertising

    Stars safeguard against morbid advertising

    As film-makers and advertisers make increasing posthumous use of celebrities' images, some stars are finding new ways of ensuring that they rest in peace
    The UK horticulture industry is facing a skills crisis - but Great Dixter aims to change all that

    UK horticulture industry facing skills crisis

    Great Dixter manor house in East Sussex is encouraging people to work in the industry by offering three scholarships a year to students, as well as generous placements
    10 best compact cameras

    A look through the lens: 10 best compact cameras

    If your smartphone won’t quite cut it, it’s time to invest in a new portable gadget
    General Election 2015: The masterminds behind the scenes

    The masterminds behind the election

    How do you get your party leader to embrace a message and then stick to it? By employing these people
    Machine Gun America: The amusement park where teenagers go to shoot a huge range of automatic weapons

    Machine Gun America

    The amusement park where teenagers go to shoot a huge range of automatic weapons
    The ethics of pet food: Why are we are so selective in how we show animals our love?

    The ethics of pet food

    Why are we are so selective in how we show animals our love?
    How Tansy Davies turned 9/11 into her opera 'Between Worlds'

    How a composer turned 9/11 into her opera 'Between Worlds'

    Tansy Davies makes her operatic debut with a work about the attack on the Twin Towers. Despite the topic, she says it is a life-affirming piece
    11 best bedside tables

    11 best bedside tables

    It could be the first thing you see in the morning, so make it work for you. We find night stands, tables and cabinets to wake up to
    Italy vs England player ratings: Did Andros Townsend's goal see him beat Harry Kane and Wayne Rooney to top marks?

    Italy vs England player ratings

    Did Townsend's goal see him beat Kane and Rooney to top marks?
    Danny Higginbotham: An underdog's tale of making the most of it

    An underdog's tale of making the most of it

    Danny Higginbotham on being let go by Manchester United, annoying Gordon Strachan, utilising his talents to the full at Stoke and plunging into the world of analysis
    Audley Harrison's abusers forget the debt he's due, but Errol Christie will always remember what he owes the police

    Steve Bunce: Inside Boxing

    Audley Harrison's abusers forget the debt he's due, but Errol Christie will always remember what he owes the police