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Thursday, July 26, 2018

What are Bonus Shares

Did you know that Stock Split is slightly different from issuing Bonus Shares? Did you know that lack of liquidity can push a company to issue Bonus Shares? Did you know that issuing Bonus Shares is a very common phenomenon?
To know more...Read on..

What are Bonus Shares?
Bonus shares are shares distributed by a company to its current shareholders as fully paid shares free of charge. Important thing is that the impact of Bonus Shares is felt only by the 'existing' shareholders, and they do not have to pay anything to have those bonus shares.

Who is issued how many Bonus Shares?
Bonus shares are distributed in a fixed ratio to the shareholders. in fact, they are issued in the same ratio as the existing ratio. No fractional shares are allowed.

Example of a Bonus Share
Prior to Issue of Bonus Shares
Person A holds : 10 shares
Person B holds : 20 shares

Company announces a 1:1 Bonus Shares
Person A holds : 10 x 2 = 20 shares
Person B holds : 20 x 2 = 40 shares

Note that the number of total shares have gone up, though the ratio of shares with each shareholder remains the same.

Do Bonus Shares impact the Value of a Company?
While the issue of bonus shares increases the total number of shares issued and owned, it does not change the value of the company. In this sense, a bonus issue is similar to a stock split.

Why does the company issue Bonus Shares?
There are various reasons for a company to go for Bonus Shares. A few important ones are as follows:
1/ Bonus shares originate from a company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares. Thus, they are a good alternative to Dividends, if the company is short of liquid funds to distribute dividends.
2/ As with Stock Splits, Bonus Shares encourage retail participation and increase their equity base. When price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. Increase in the number of shares reduces the price per share.
3/ When companies are short of cash and shareholders expect a regular income, Bonus shares may be issued. Shareholders may sell the bonus shares and meet their liquidity needs
4/ Bonus shares may also be issued to restructure company reserves. Issuing bonus shares does not involve cash flow. It increases the company’s share capital but not its net assets.
5/ issuing bonus shares increases the issued share capital of the company, the company is perceived as being bigger than it really is, making it more attractive to investors.

Bonus Shares Vs Stock Splits
A bonus issue works in almost the same way except that instead of having your shares split into 2, the company issues you one additional fully paid share free of charge so that you will also own 2 shares after the bonus issue.
The bonus share results in reduction of reserve capital which is used to create new shares, while Stock split results in reduction of face value of stock.

Stock Split Example
Stock price : Rs.50 per share
Face Value : Rs.10 per share
Outstanding shares : Rs. 10,000
Market capitalisation : Rs. 50 x 10,000 = Rs. 5,00,000
Reserve Capital with the company : Rs. 2,00,000

After a Stock Split in 1:2 ratio
Stock price: Rs.25 per share (reduces by half)
Face Value: Rs.10 / 2 = Rs. 5 per share (reduces by half)
Outstanding shares: 10,000 x 2 = 20,000 (doubles)
Market capitalisation : Rs. 25 x 20,000 = Rs. 5,00,000 (no change)
Reserve Capital with the company : Rs. 2,00,000 (no change)

After issuing a 1:1 Bonus Share
Stock price : Rs.25 per share (reduces by half)
Face Value: Rs.10 (remains same)
Outstanding shares: 10,000 + 10,000 (bonus) = 20,000 (doubles)
Market capitalisation : Rs. 25 x 20,000 = Rs. 5,00,000 (no change)
Reserve Capital with the company : Rs. 1,00,000 (reduces by half)

How does issue of Bonus Shares impact the Financial Ratios like EPS
Bonus Shares impact all financial ratios involving number of shares, since the number of issued shares have increased. So, the impact on many financial ratios is definite, just like in the case of Stock Splits. Please read about Stock Split to understand more about it.

What are the demerits of issuing Bonus Shares?
1/ Because issuing bonus shares does not generate cash for the company, it could result in a decline in the dividends per share in the future, which shareholders may not view favorably.
2/ Shareholders selling bonus shares to meet liquidity needs lowers shareholders' percentage stake in the company

Summary
Issuing Bonus Shares is a common phenomenon in the Stock Market. There are hundreds of companies issuing Bonus Shares (and also undergoing stock splits) every year. 
Here is a list of some companies issuing Bonus shares: 
https://www.moneycontrol.com/stocks/marketinfo/bonus/index.php
But do not feel that you must take a plunge into a company just because you know that it is likely to announce bonus shares. They do not add any value to the company as such - just like Stock Splits.

Regards

Manoj Arora

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