Bonus Shares commonly known as “scrip dividends” are company’s accumulated earnings which instead of being given out in the form of dividends are converted into additional/free shares to be given to current shareholders in proportion to each shareholder’s stake without any additional cost. However, bonus share can be issued only by the company which has accumulated large free reserve, i.e. reserve not set apart for any specific purpose and can be distributed as dividends.
Example: Bonus share in ratio 2:3 means for you get two additional shares without any cost for three shares you already hold in the company.
Circumstances of issuing bonus share?
If a company is profit-making, its accumulated profits and reserves will go on increasing. Thus, actual capital employed is much higher than the amount of share capital. The profit so generated is much higher as compared with share capital. To avoid this abnormality in the capital structure, part of free reserve is distributed among the existing shareholders by issuing Bonus Shares.
Issued shares apart from increasing the voting power of promoters marginally, also increase the volume of stock in hand, providing a better position to trade and speculate well in the market without the risk of being voted out. However, bonus share can’t be issued in place of dividends, making it a rational method of tackling the dividend tax burden.
Liquidity of the Stock
The purpose of issuing bonus share is to increase liquidity in the stock and hand out the available distributable net worth in a cash-neutral manner. However, companies issue bonus shares to encourage retail participation and increase their equity base, while providing a positive sign to the market that the company believes in its long-term growth story.
Sometimes, the company may not be in a position to pay any cash, so bonus issue is the only option left with the company to satisfy the shareholder’s desire for a dividend. Bonus share is taken as a sign of good health of the company. Usually, after the bonus issue, the share price of the company gets adjusted according to the bonus ratio offered.
Wipro’s price before bonus in 2017 was Rs 536 (9.7.17) and company issued bonus share price in the ratio 1:1, the post bonus share price was Rs 256.90 (14.6.17), which means that the total market value (2*Rs 256.90) remains the same.
Does a Bonus share benefit investors?
- Bonus shares does benefit investors as they do not need to pay any additional amount for additional shares.
- Investors are exempted from tax payment and is beneficial for those who believe in the long-term growth story of the company.
- 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, more often than not, 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. So, when stock prices move up in the long run, there will be a dramatic increase in the wealth of shareholder.
- Apart from this investor can gain its benefit in situations when the company decides to distribute its cash dividends, the investor receives more profit because they hold additional number of shares in the company due to its past policy of paying bonus.
If in 1980 you had only 100 shares of Wipro you would be holding 9.6 million share by 2010. Their worth would have been Rs 472.32 crore and does not include dividend over 3 decades.
|Year||Action||Number of Shares|
|1986||Stock split to FV Rs.10||4,000|
|1999||Stock split to FV Rs.2||9,60,000|
This is one of the major reasons one should stay invested for a long period in good stocks to enjoy the benefits of dividends as well bonus shares.
Thing to Note in a Bonus
However, one should not invest purely on the basis of expected bonus shares unless one is certain about the fundamentals of the company. Although earning per share of the stock will drop in proportion to new issue it is compensated by the fact that investor will win more share, therefore the value of investment should remain same although the price will adjust accordingly.
Not all investors may be interested in receiving the shares as a bonus; some may want liquidity for fulfilling other needs. When such investors sell their bonus share for generating liquidity, their stake in the company is reduced.
From Announcement of Issue till “ex bonus”
When a bonus issue is announced, the company also announces a “Record date” for the issue. The record date is one on which bonus takes effect, and shareholders on that date are entitled to the bonus. After the announcement of the bonus but before the record date, the shares are referred to as “Cumbonus.”
After the record date, when the bonus has been given effect, the shares become an “Ex-bonus.” The price usually hikes after the announcement of the bonus shares, because investors feel that they can gain profit if they own the shares before the record date, but decline on the record date.
Effects of Bonus on Share Price
Stock price of a company rises after the announcement of issue. But our analysis splits its effect into two parts:
- Effect on share price before the day of issue bonus share and
- Effect after the day of issue of the bonus share.
|Company Name||Bonus Issue Date||Ratio||Price a day before(cumbonus)||Price a day after(Ex-bonus)|
Thus, overall, bonus shares a boon for the investors and mark the increase in value of the company.