What is a Bonus Issue?

Stocks reward you in many ways. Apart from the regular interest free dividends and the capital appreciation on the stock value, investments in company shares also fetch you certain non monetary benefits to you. Bonuses and Rights issue are two such noticeable benefits.

Let us understand in detail about the Bonus issue.

What is a Bonus Issue?

Instead of distributing the entire accumulated profit as dividends, the company has the option of issuing bonus shares to its existing shareholders. Issue of bonus shares results in the conversion of the company's profits into share capital. Therefore it is termed as capitalization of company's profits.

Bonus Shares, as the name suggests, are additional shares issued to the existing shareholders free of cost as a bonus. Prima facie, it does not impact your wealth as a shareholder.

How does Bonus Issue Work?

If a company X issues bonus shares in the ratio of 1:1 and assuming that you are holding 200 shares of this company, you will receive another 200 free bonus shares from the company free of cost. Normally, the price of the stock in the stock market would fall to keep your overall wealth the same.  This reduced price is called as the ex-bonus price.

As an example, if you were holding 200 shares worth Rs. 50 a share before declaration of 1:1 bonus issue, then your total wealth was Rs. 50 * 200 = Rs. 10,000/-. After you get the bonus shares, the most probable price of the stock would fall by 50% to about Rs. 25. Hence your total wealth would still remain the same ie Rs. 25*400 shares = Rs. 10,000/-

Benefits of Bonus Shares for the Company and the Investor

1. Since such shares are issued to the equity shareholders in proportion to their holdings of equity share capital of the company, a shareholder continues to retain his / her proportionate ownership of the company.

2. The bonus issue tends to bring the market price per share within a more reasonable range.

2. It increases the number of outstanding shares. This promotes more active trading.

3. The nominal rate of dividend tends to decline. This may dispel the impression of profiteering.

4. Share capital base increases and the company may achieve a more spectacular size in the eyes of the investing company.

5. Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened and they can reasonably look for an increase in total dividend.

6. It improves the prospects of raising additional funds.

Cheers

Manoj Arora