Everything You Need to Know About Bonus Shares
Bonus shares are additional shares that a company issues to its existing shareholders for free as a way of distributing its profits or reserves. Companies give bonus stocks to the shareholders in proportion to their existing shareholding.
The issuance of bonus shares is a common practice among public companies and can have various implications for investors. In this blog, we will delve deeper into the concept of bonus stocks, their benefits, drawbacks, and how investors can analyze them to make informed investment decisions.
Bonus Shares Meaning
Bonus shares, also known as scrip dividends or capitalization issues, are additional shares issued to existing shareholders by a company. These are free of cost, based on the number of shares they already own.
These shares are issued by converting the accumulated reserves and profits of the company into equity shares. Bonus shares do not result in any change in the total market value of the company. However, they reduce the value of each share proportionately.
Moreover, these are not bonus paying stocks. Instead, bonus shares are a distribution of additional shares to existing shareholders, without any cash outflow from the company.
Types of Bonus Shares
There are two types of scrip dividends. They are as follows:
1. Fully paid bonus stocks
Companies issue these without any additional payment required from shareholders. Once these shares are issued, they are fully paid and have the same rights and privileges as existing shares. For example, if a company declares a 1:1 bonus issue, each shareholder will receive one bonus share for each share they currently own, without having to pay anything extra.
2. Partly-paid-up bonus stocks
Companies issue these shares with a requirement for shareholders to pay a portion of the face value of the shares. In this case, shareholders receive the bonus stocks but are also required to pay a certain amount per share over and above the amount they have already paid for their existing shares.
For example, if a company declares a 1:2 bonus issue of partly paid-up shares with a face value of ₹10 each, shareholders need to pay ₹5 per share to receive the scrip dividends. This means that for each existing share they own, they will receive two bonus shares, but they will also have to pay ₹5 per share to get these bonus shares.
Why do Companies Issue Bonus Stocks?
Companies issue scrip dividends for several reasons, including:
- Rewarding shareholders: Companies issue bonus stocks to existing shareholders. It is often seen as a sign of a company’s financial health and stability.
- Increasing liquidity: Bonus shares increase the number of stocks outstanding, which can improve the liquidity of the stock.
- Attracting new investors: Issuing scrip dividends can make the stock more affordable for investors who may have been previously deterred by a high share price.
- Improving trading activity: Bonus issuing of shares can increase the trading activity of a stock. This can be beneficial for the company and its shareholders.
- Increasing market capitalization: Bonus Issuing of shares can increase a company’s market capitalization. This can attract more investors and improve the company’s overall financial standing.
What is the Eligibility Criteria for Issuing Bonus Shares?
The eligibility criteria for companies giving bonus shares vary depending on the jurisdiction and regulations governing the company. In India, the Companies Act, 2013, sets the eligibility criteria for issuing bonus shares, which are as follows:
- The company giving bonus shares must have sufficient reserves in its books, which it can use later for issuing bonus stocks.
- The company must have the power to capitalize its reserves in its Articles of Association.
- The bonus issue of shares must be authorized by the company’s Articles of Association or by a special resolution passed in a general meeting.
- The bonus issue must be recommended by the board of directors and approved by the shareholders.
- The bonus issue of shares must comply with the guidelines issued by the Securities and Exchange Board of India (SEBI) and other regulatory authorities.
It’s mandatory for companies giving bonus shares to meet all the eligibility criteria to avoid any legal or regulatory issues.
Difference Between Stock Split and Bonus Shares
Companies use stock splits and bonus stocks to adjust the number of outstanding shares. The key difference between bonus stocks and the stock split is the motive behind each method.
Bonus shares are additional shares that a company issues to its existing shareholders without charges. Companies issue scrip dividends to reward their shareholders by increasing the number of shares they hold in the company. The company may issue bonus shares when it has accumulated substantial reserves or when it wants to boost its stock price.
On the other hand, a stock split is a method of increasing the number of outstanding shares by dividing the existing shares into smaller units. For example, a 2-for-1 stock split will double the number of outstanding shares but halve the price per share. Companies do this to make their shares more affordable for investors or to improve liquidity in the stock.
In a nutshell, both bonus shares and stock splits increase the number of outstanding shares. However, the main difference is that issuance of bonus shares works as a reward to existing shareholders. While stock splits are done to increase the number of outstanding shares and improve liquidity.
Benefits of Bonus Shares
- Increased liquidity: Scrip dividends increase the number of shares outstanding, which can improve liquidity in the stock. This can make it easier for investors to buy and sell shares in the market.
- Shareholder value enhancement: These shares are a way for companies to reward their shareholders without affecting the cash position of the company. By issuing bonus shares, the company can increase the number of outstanding stocks. That too without issuing any new shares, which can increase the value of the shares held by the shareholders.
- Positive signal to the market: Scrip dividends are generally seen as a positive signal by the market. Because they indicate that the company is doing well and has the ability to reward its shareholders. This can lead to an increase in investor confidence and can result in a rise in the stock price.
- Tax benefits: These are generally tax-free for shareholders. This can result in tax savings for investors.
Factors to Consider When Analysing Bonus Shares
1. Reason for issuing bonus stocks
The reason behind the issuance of bonus stocks is a crucial factor to consider. Companies may issue bonus stocks for various reasons, such as improving liquidity, rewarding shareholders, or increasing market capitalization. It is important to understand the underlying reason to determine if the issuance of a scrip dividend is beneficial for the company and its shareholders.
2. Impact on earnings
Issuing bonus stocks can have an impact on the company’s earnings. This happens because it increases the number of shares outstanding without changing the underlying earnings of the company. This can result in the dilution of earnings per share, which can impact the stock price. It is important to analyze how the issuance of bonus shares may affect the company’s earnings and future growth potential.
3. Dilution of ownership
The issuance of these shares can result in a dilution of ownership. As the existing shareholders will own a smaller percentage of the company after the issuance. This can impact the voting rights and control of the company. It is important to understand how the issuance of scrip dividends may impact the ownership structure and control of the company.
4. Market Reaction
The market reaction to the issuance of bonus stocks can also be an important factor to consider. The announcement of bonus stocks can lead to a positive or negative reaction from the market. Depending on the reason for the issuance and the impact on the company’s financials. It is important to analyze how the market may react to the issuance of bonus shares and how it may impact the company’s stock price.
Impact of Bonus Stocks on Fundamental Analysis
Financial Ratios
Scrip dividends can impact financial ratios such as price-to-earnings (P/E) and price-to-book (P/B) ratios. When a company issues bonus stocks, the total number of stocks increases, which can lead to a decrease in the price per share. This, in turn, can result in a decrease in the P/E and P/B ratios.
Earnings and Revenue Growth
Bonus share do not impact a company’s earnings and revenue growth directly, as they do not change the underlying earnings or revenue of the company. However, scrip dividends can impact the per-share earnings and revenue figures. Because the total earnings and revenue are now divided among a larger number of shares.
Shareholder Equity
Bonus issuing of shares can also impact a company’s shareholder equity. When scrip dividends are issued, the value of the company’s assets remains the same, but the number of outstanding shares increases. This results in a decrease in the book value per share, which can impact the shareholder equity and the company’s overall financial health.
Impact of Bonus Shares on Technical Analysis
Scrip dividends can have an impact on technical analysis in several ways.
Firstly, the issuance of bonus shares can lead to a decrease in the stock price due to dilution. This can be reflected in technical indicators such as moving averages, trend lines, and support and resistance levels. Traders who use these indicators may need to adjust their strategies to account for the impact of the bonus shares on the stock price.
Secondly, the issuance of bonus shares can increase the liquidity of a stock, which can impact trading volume and volatility. This can be reflected in technical indicators such as average true range and trading volume. Traders who use these indicators may need to adjust their strategies to account for the potential increase in volatility and trading volume.
What is Record Date?
The record date is the date on which the company determines the list of shareholders who are eligible to receive bonus stocks. Only those shareholders who are on the company’s record on or before the record date will receive bonus shares.
The company’s board of directors determines the record date and is announced in advance to the stock exchanges and shareholders. It is an important date for investors as it determines their eligibility to receive scrip dividends.
To Wrap It Up…
Bonus stocks are a way for companies to reward their shareholders without affecting the cash position of the company. Issuing scrip dividends also helps companies to improve their market value, increase liquidity, and enhance the confidence of investors.
As an investor, it is important to understand the concept of bonus shares and how they can impact your investment portfolio. Moreover, you can check out modern investment products like smallcase and exercise portfolio investing to invest in the stock market. It provides you with ready-made portfolios in which you can invest with just a few click.
