What is Bonus Share?

Benefits of Bonus Share Issue

Introduction

Bonus share Issue is a way of distributing the corporate’s earning to the shareholders, not given out in the form of dividends but converted into free shares.

What is Bonus Share?

• Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends, but are converted into free shares.
• The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
• For instance, if Investor A holds 100 shares of a company and a company declares 4:1 bonus, that is for every one share, he gets 4 shares for free. That is total 400 shares for free and his total holding will increase to 500 shares.
• Notice that Whenever a bonus issue is announced, the company also announces a record date for the issue. Record date is the date on which the bonus shares takes effect, and shareholders are entitled to the bonus shares on that date.

How bonus shares are issued?

• Bonus shares are generally issued by using the free reserves of the company. Every year, companies retain some part of their earnings and give the remaining part to shareholders in the form of dividends, as the most common way.
• Companies accumulate these retained earnings over time. So, with the bonus issue, these reserves will be converted into the capital. If we take a closer look at the balance sheet, we observe that capital is simply being transferred from the retained earning account to paid up capital account.
• Hence, the overall shareholder’s equity remains same. So, when bonus shares are issued, bonus prices will adjust according to the bonus ratio keeping the total market capitalization of the company same.
• So, if a bonus issue of 1:1 is announced, share price will half and no. of shares with the shareholders will double

Impacts of Bonus Share Issue

• In most of the cases, the stock price of a company rises after a bonus issue. While analyzing the effect of bonus issue on the share price of the company in two stages.
  • Share price movement from the time the issue is announced till the record date
  • Share price movement one year after the record date
• It can be seen that there is a positive trend in the share price movement of the company post bonus issue announcement till the record date and even one year after the bonus issue date.
• After the bonus issue, the share price of the company gets adjusted as per the bonus ratio i.e. the total market value of the company remains same. To understand this, consider one example. Suppose the stock price of a company before bonus is Rs 200 and a company issues bonus shares in the ratio of 1:1, the post-bonus share price will be Rs 100 and the total market value (2 x Rs 100=Rs 200) remains the same.
• Bonus share also increase liquidity. As in above example, after bonus share, stock price of the company will adjust as per the bonus ratio. So, stocks are available at a lower price now, thus increasing liquidity. It makes it easier to buy and sell.
• After bonus share, the value of Earning per share or EPS will go down.
• Earnings per share (EPS) = Net Profit / Number of shares
• As the profits remain the same and the number of shares increases, the value of Earnings Per Share (EPS) will go down.
• Since total numbers of shares are increased as a result of bonus issue, dividend per share may be less.

Benefits

A. From Company’s Perspective :

1. By issuing bonus shares, companies can satisfy shareholders when they don’t have enough cash to pay dividends. They can then use the cash in their expansion or other planned projects.
2. Issuing bonus shares means capitalisation of profits, which always increases the credit worthiness of the company. It also improves their credit rating which means they can borrow at a better rate.
3. A bonus issue indicates that the company is booming and it is in a position to service its larger equity.
4. Liquidity cash position of the company will remain unaltered with the issue of bonus shares because issue of bonus shares does not result into inflow or outflow of cash.

B. From Shareholders’ / Investors’ Perspective :

1. Shareholders need not pay tax on the bonus shares. However, in the case of dividends, they need to pay tax. It is beneficial for those investors who believe in the long-term growth story of the company.
2. If needed investors can sell some of the shares to meet their cash demands, thus increasing the flexibility for them.
3. Shareholders will get additional shares as a result of bonus issue. So, the investors will get additional dividend as a result of additional shares.
4. Issuance of bonus share leads to increase investor’s confidence in operations of the company. Post the bonus, the share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the shareholder. However, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.
5. So, when stock prices move up in the long run, there will be a dramatic increase in the wealth of shareholder.