What is a Bonus Issue?
A bonus issue is a corporate action where a company offers extra shares to the existing shareholders without any extra cost. These extra shares are issued in proportion to the existing number of shares held by the shareholder. A bonus issue may be sought as an alternative to dividend payouts. Companies can capitalise their reserves by issuing bonus shares. In a bonus issue, the number of shares increases while the investment value stays the same.
Pros and Cons of a Bonus Issue
- Increased Liquidity: Bonus shares provide investors with extra shares and provide more liquidity for the stock.
- Tax Benefits: The extra shares allotted to the shareholders are not subject to taxation.
- Increased Affordability: The price per share decreases as more shares are issued, making it more affordable to investors.
- More Dividends: Holders of bonus shares receive a larger dividend when the company increases the payout per share in future since they now possess a larger proportion of the company’s shares. However, post-the bonus issue, the dividend per share decreases proportionately.
- Increased Volatility: The prices of the stock become more volatile as a result of speculation and shifts in market sentiment.
- Larger Capital Depletion: Compared to paying dividends, issuing bonus shares requires more capital from the cash reserve.
- Decreased Earning per Share (EPS): The company’s profit remains the same and the number of shares increases, therefore the EPS decreases proportionally.
What is a Stock Split?
A stock split is a corporate action in which a company issues additional shares to present shareholders to increase the number of outstanding shares. A stock split results in an increase in the number of total shares and a proportionate decrease in the share price, while the market capitalization and value of the company remain constant. The face value of a share also decreases proportionately.
Pros and Cons of a Stock Split
- Makes the Stock Affordable: A stock split decreases the share price proportionately. Thus, making the stock affordable to investors.
- Increase Liquidity: Splitting a stock increases the number of shares that are accessible. As a result, the investors find it simpler to acquire and sell shares.
- Ease of Diversification: It is simpler to diversify and rebalance the portfolio because of more shares and lower share prices.
- Prevent Stock Dilution: Companies can increase the number of shares by splitting their stock, as opposed to issuing new shares through a secondary offering. This can prevent stock dilution.
- Expensive Procedure: A stock split is an expensive process that needs to be done under legal supervision and in conformity with regulatory laws.
- No Additional Value: A stock split does not affect a company’s fundamental position and consequently adds no value.
- More Volatility: Because of the new share price following a stock split, the stock becomes more accessible. More investors might decide to buy it, which can raise the stock’s volatility.
Bonus Issue vs Stock Split
Face Value: The face value of a share remains the same in a bonus issue while it changes proportionately in a stock split.
Division of Share: A stock split divides a single share into two or more shares according to the split ratio, whereas a bonus issue gives current shareholders an additional share.
Purpose: A bonus issue may be sought as an alternative to dividend payouts. On the other hand, a stock split makes the stock look more affordable to investors.
For a 5:1 bonus issue, shareholders will receive five additional shares for every share held. For 20 shares, a shareholder will receive 100 additional shares after a bonus issue. Thus, the total shares held by the shareholder after the bonus issue will be 120 (100+20).
For a 1:3 stock split, each share will be split into 3 shares. Thus, a shareholder holding 10 shares will have a total of 30 shares after a stock split.
In a bonus issue, the number of shares issued directly affects the share price. Let’s assume the company announces a 5:1 bonus issue.
Share price before bonus issue: 500
Total number of shares held before bonus issue: 100
After Bonus Issue
Share price after bonus issue: 100 (500/5)
Additional shares allotted: 500
Total number of shares held after bonus issue: 600 (100 existing + 500 additional shares)
The face value, however, remains the same after a bonus issue.
In a stock split, the number of shares issued will also affect the share price.
Let’s assume the company announces a 1:3 stock split.
This indicates that every share held will be split into three shares.
Share price before stock split: 500
Total number of shares held before stock split: 100
Face value of share before stock split: 20
After Stock Split
Share price after stock split: 166.66 (500/3)
Total number of shares held after stock split: 300
Face value of share after stock split: 6.66
It is important to note that the market capitalization remains the same before and after the stock split. The formula for market capitalization is as follows:
MC = N X P
MC: Market Capitalization
N: Number of outstanding shares
P: Price of each share
For instance, if the market capitalization of a company is Rs 1,00,000 with 10,000 shares, each share is valued at Rs 10 and the shares are split in a 1:2 ratio. That means that every shareholder holding 1 share, will receive 2 shares. The number of shares, in this case, increases to 20,000 shares but the value per share reduces to Rs 5. This way the market capitalization remains the same.
Frequently Asked Questions
Companies issue bonus shares when they are unable to pay a dividend in cash due to a lack of liquid funds. Even in cases where they do not have a scarcity of funds, companies frequently issue bonus shares. Some companies use this tactic to avoid paying the heavy Dividend Distribution Tax, which must be paid when declaring dividends. The companies also issue bonus shares to reduce the share price and make the stock more affordable to investors.
The company appears larger than it is because of the issuance of bonus shares, which boosts the issued share capital of the company and increases its desirability to investors. Additionally, a higher share count results in a lower share price, which lowers the cost of the stock for retail investors and makes it more affordable to investors.
Companies opt to split their stock after share prices reach a certain high price since it will enable additional investors to purchase shares at a lesser price.
The increase in the number of shares leads to more liquidity in stocks. As a result, the investors find it easier to acquire and sell shares.
A reverse stock split is an action where a company merges the existing shares into fewer yet higher-priced shares. In a reverse stock split, the number of shares is divided by a certain number, such as five or ten, creating a 1-for-5 or 1-for-10 reverse split, respectively. Reverse stock splits are used by corporations to increase stock prices by reducing the number of outstanding shares. Companies usually perform this corporate action to avoid getting delisted from the exchange and also to improve their reputation.