Bonus Share

Finnovationz - December-17-2018

Bonus Share

The word "Bonus" has its own beauty & is always welcome. But it may not be the case for bonus shares. why? Let's see.

The bonus shares are the additional free shares given to current shareholders of the company. In simple words, free extra shares gifted to shareholders. Sometimes the term "Bonus Shares" misguides investors. They think that with bonus issue they will get new shares. Yes, they get new shares but at the same time price of those shares decreases in the given proportion.

A 1:1 bonus means that a shareholder will get one share for each share held by him. For example, if someone is holding 10 shares, he will get 10 more. The shareholders do not pay anything for these shares. 2:1 bonus means that for every one share, shareholder will get two shares for free. Free shares are given to the current shareholders, based upon the number of shares that a shareholder owns.

After the bonus issue, the share price of the company gets adjusted according to the bonus ratio.

For example,

Before bonus share issue:

Suppose, the price of a share of company PQR is Rs 1000 & no. of shares outstanding are 1000. Hence market capitalisation= 1000*1000 ( No. of shares outstanding* Price of a share) = 10,00,000.

After Bonus Share Issue:

Now company PQR issues bonus shares in the ratio of 1:1 (i.e, a shareholder will get one share for each share held by him/her), the post-bonus share price would be Rs 500 & no. of outstanding shares would be double i.e, 2000, which means that the total market capitalisation (2000 x Rs. 500=Rs. 10,00,000) remains the same. Hence, market capitalisation will be same before and after bonus share issue. Similarly personal holding will be same before & after bonus issue. For example, If you had 5 shares of the company PQR of price Rs. 1000 each before bonus issue then you would have 10 shares of  company PQR of price Rs. 500 after bonus issue of 1:1. You can notice there was a change in the stock price, the number of outstanding shares but market capital remains the same & hence value of your total holding remains same. In bonus share issue, face value does not get altered. If it was 10 earlier, it continues to be 10.

The advantage of issuing bonus is that it makes the share more liquid. For example, in the above example, the share price has been halved & hence many more people would be able to buy the shares, as compared to when it was Rs 1000. This is very well appllied to the stocks whose price is above 3000 to 4000.

After the announcement of a bonus issue, a record date is fixed for the issue. Record date is fixed by the company to determine who is eligible for bonus shares. You get the benefit only if you have shares in your Demat account on the record date. Shareholders must have their stakes on that particular date.

Ex-Bonus Date: Ex-Bonus Date is usually one day before the record date. Those who invested during this phase are not entitled to the bonus shares. If you are buying shares on Ex bonus date, then you are not eligible for bonus share. But if you are selling shares on ex-bonus date, then you will be eligible for bonus shares. Because in India settlement is done on T+2 basis i.e, If you buy shares today, they will find their place in your Demat account after two days(T+2).

For e.g, If you buy shares on Monday then they will come into your Demat account on Wednesday, provided Monday, Tuesday & Wednesday are business days. Hence, you should buy shares one day before ex-bonus date so that shares bought prior to ex-bonus date will find their place in Demat account of the investor on the record date. When seller sells shares on ex-bonus date, settlement happened on T+2 day i.e, one day after the record date, & on the record date, seller's name is still there on the books & hence seller gets the bonus share.

When a company earns profit, it may distribute some part of its profit as dividends or keep the some part as a reserve for future investments. At some stage company might want to capitalise on this reserve i.e, convert part of the reserves into shares. In simple words, when a company convert part of the reserves into shares and distribute it to shareholders, we say the company has issued bonus shares.

To give bonus shares to investors, the company builds a reserve by retaining a part of its profit  instead of paying it to shareholders in the form of dividend. When the free reserve increases, the company transfers part of the money into the capital account, from which it issues bonus shares. The company pays for dividend or bonus shares through the reserve cash. Issuing bonus shares take out more money from the reserve than dividends. After the issue of bonus shares, the capital rises and the free reserves reduce. Mahindra & Mahindra, TCS, L&T, Ranbaxy and HDFC, Wipro etc have issued bonus shares.

After the bonus issue, Earning per share (EPS= total earnings / No. of shares outstanding) of the company decreases because after bonus share issue, the number of shares outstanding increases. So, as the number of shares increases, the EPS decreases. Effective Earnings per share, Book Value and other per share values stand reduced.

Like the stock split, the most common reason for issuing bonus shares is that the share price has become high and is affecting demand. As small retail investors cannot buy shares with a high price, hence by issuing bonus shares they are affordable to retail investors & it improves the liquidity of the stock. Stock splits are mainly carried out with the intention that the stock should be affordable to small investors which will eventually enhance the liquidity of the stock. It increases liquidity and retail participation. In both stock split & bonus share, the no. of shares outstanding of a company increases. Both serve to increase the total number of issued shares, making shares cheaper for investors to trade and consequently, boost trading liquidity.

For example,  If your investment amount is 50,000 then you can buy just one share of MRF. Hence, small investors avoid stocks like BOSCH, MRF, EICHER MOTORS etc. To overcome this problem companies usually come up with the stock split or bonus issue. But some companies do not believe in bonus share issue, they just never issue bonus issue.

For example, Warren Buffett's Berkshire Hathaway has never issued bonus share or stock split because Buffett does not believe in bonus shares & stock split. Today the price of a share of Berkshire Hathaway is more than Rs. 1 crore.

In most cases, the stock price of a company rises after a bonus issue. Some experts say that the announcement of bonus shares has a positive impact on share price while others say that "The announcement of bonus shares has no effect on share price. After the announcement, the stock can move in either direction depending on the market sentiment."

If you want to buy shares of companies which are going to announce bonus issues, thinking that price of its price will soar, hold on. One should not buy purely on the basis of expected bonus shares unless one is certain of the fundamentals of the company. "A bonus issue is a sign the company is expanding equity and increasing liquidity, but it does not guarantee the performance of the company". Investors should take a decision after analysing the fundamentals of the company. As the share price depends on the fundamentals and growth prospects of the company.

A bonus issue is generally perceived to be positive by investors because it shows that company is confident of more earning in the future, that’s why it can afford to issue extra shares to investors by reducing its reserve capital, indirectly indicating continued better prospects. Only companies with  bright prospects issue bonus shares and thus does not mind diluting capital.

Difference between stock split & bonus share:

1) In the stock split, face value is also reduced in the proportion of split but in bonus shares, face value does not get altered.  Benefits like dividends are always declared on the face value. Hence, investors get more dividend in bonus stock than in stock split.

2) Bonus share is the additional share, whereas stock split simply divides existing outstanding shares held by shareholders into multiple shares.

3) In bonus issue, reserve capital of the company decreases whereas stock split does not affect company's reserve capital.

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