Last Updated on September 22, 2023 by BFSLTeam BFSLTeam
Many investors think that the closing price of a stock is determined by taking the price at which the last trade happened. However, that’s far from the truth. In fact, the closing price is determined by taking a weighted average of all the prices of trades that happened during the last 30 minutes (3:00 PM to 3:30 PM) of a trading day. This weighted average price is then set as the closing price of a stock. Due to the calculation involved, it takes a few minutes from the close of the trading session to determine and publish the closing price of a stock. As an investor, being aware of just the closing price isn’t enough. You also need to know the meaning of adjusted closing price. The adjusted closing price is a similar but slightly different concept. Continue reading to know more about what it is and why stock exchanges adjust the closing price of a stock.
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What is the Adjusted Closing Price?
The adjusted stock price is the term market experts use to refer to the closing price of a stock after factoring in the effect of corporate actions like dividend payments, stock splits and rights issues. The stock exchanges typically perform these adjustments to ensure that the corporate actions don’t materially affect the closing price of the stocks.
How is the Closing Price Adjusted?
Now that you know the meaning of adjusted closing price, let’s look at how the exchanges determine the adjusted close price of a stock. The type of adjustment that the exchanges make will vary depending on the nature of corporate action undertaken by the company.
Also Read: Dual-Class Shares?
Closing Price Adjustment in the Case of a Stock Split
A stock split is a corporate action where the company splits the value of its stock in a particular ratio such as 1:2 or 1:3. This is often done to reduce the value of shares and increase the number of outstanding shares. Stock splits boost liquidity and make the shares more attractive and affordable to retail investors.
Here’s a hypothetical example of how exchanges arrive at the adjusted close price of a stock that is split in a 1:2 ratio. Assume there’s a company XYZ Limited whose closing stock price is ₹1,000. The total number of outstanding shares of the company is 10 lakhs.
The company decides to split its shares in a 1:2 ratio, meaning that every share would now become two shares. This increases the number of outstanding shares to 20 lakhs. To ensure that this major change in the capital structure is reflected appropriately, exchanges divide the closing price by 2 to arrive at the adjusted close price of ₹500 (₹1,000 ÷ 2).
Closing Price Adjustment in the Case of a Dividend Payment
In the case of dividend payments, exchanges simply subtract the amount of dividend paid from the closing price of the stock to arrive at the adjusted close price. For instance, if the closing price of XYZ Limited is ₹1,000 per share and the company paid out a dividend of ₹10 per share, the adjusted closing price would be ₹990 (₹1,000 – ₹10).
Closing Price Adjustment in the Case of a Rights Issue
A rights issue is a method through which a listed company raises funds from its current crop of shareholders instead of the public. In a rights offering, the company offers its shareholders the right, but not the obligation, to purchase additional shares at a price lower than the current market price. Interested shareholders can exercise this right and purchase additional shares or sell the right to other outside investors through the secondary market.
Here’s a hypothetical example of how the adjusted close price of a stock is determined in the case of a rights issue. Assume that XYZ Limited whose total outstanding shares is 10 lakhs announces a rights issue in the ratio of 1:1. This means that shareholders are entitled to purchase 1 additional share for every 1 share held in the company.
The rights issue price set by the company is ₹900, a discount of ₹100 from its closing price of ₹1,000. Now, let’s say that all of the company’s existing shareholders exercise their right and purchase 1 additional share for every 1 share held by them. This increases the total number of outstanding shares from 10 lakhs to 20 lakhs.
To arrive at the adjusted close price of XYZ Limited, you simply add the closing price of ₹1,000 with the rights issue price of ₹900. Then, divide the sum of these prices by 2 since the total number of outstanding shares has doubled. This should give you an adjusted closing price of ₹950 [(₹1,000 + ₹900) ÷ 2].
Also Read: Closing Price
Conclusion
The exchanges typically adjust the closing price of a stock in three scenarios – stock splits, dividend payments and rights issues. The adjustment is done to ensure that the stock price reflects its true value. Also, it makes it easier for traders and investors to accurately evaluate the stock performance. Furthermore, since the adjusted close price accounts for corporate actions, it makes comparisons between stocks and other asset classes more meaningful.
That said, some market experts have a contrarian view of the concept of adjusted closing prices. They claim that an adjustment made to the closing price would wipe out useful information such as the trading activity of the last 30 minutes of an asset, making it harder to detect the market trend.
