Bonus Issue of Shares: Meaning, Advantages and Disadvantages and Impact on Stock Price

In the previous chapter, we delved into the concept of dividends, exploring what a dividend is and what a cash dividend is. In this chapter, we will take a look at another type of dividend, i.e. bonus issue.

A bonus issue is also known as a stock or scrip dividend. It is a corporate action where a company issues additional shares to its existing shareholders at no extra cost. These additional shares are allocated in a fixed ratio to the shares already owned. Rather than drawing additional investments, a bonus issue capitalises on the company's retained earnings to increase the number of shares in circulation, which can potentially make the stock more accessible due to a lower per-share price. This is a strategy used primarily to reward shareholders and can signal confidence in the company's prospects.

For example, a company might announce a bonus issue with a ratio of 1:5, meaning each shareholder receives one additional share for every five shares they own. This action increases the total number of shares issued, thereby diluting the share price. However, it doesn't alter the company's net assets. Instead, it redistributes part of the company's retained earnings to the share capital account without impacting the overall equity value.

Below is an illustration to understand this better:

Mr Ramesh has 100 shares in a company, each costing ₹15. Suppose the company declares a 2:1 bonus or two free shares for every share held by the shareholders. Mr Ramesh’s Demat account will now show a total of 300 shares. Intriguingly, despite the increase in share amount, the total investment value will remain unchanged.

Initial investment value before the bonus issue: 100 × 15 = ₹1,500

Investment value after the bonus issue: 300 × 5 (i.e. 1500/300) = ₹ 1,500

The shares must, however, be acquired before the ex-date for the shareholders to qualify for the bonus.

The allocation of these bonus shares is typically in predetermined ratios like 1:1, 2:1, or 3:1. So, does the bonus issue decline the value of the stock? Well, no! This only reduces your cost per share.

While the stock price may decrease in proportion to the bonus ratio, you should not confuse this reduction with a negative market correction or a decline in the stock's inherent value.

For example, with a 2:1 bonus issue ratio, a shareholder owning 100 shares would receive an additional 200 shares for free. This increases their total holdings to 300 shares. Despite the increase in share quantity, the total value of the shareholder’s investment remains constant.

To further illustrate, consider bonus issues at various ratios - 1:1, 3:1, and 5:1. In each scenario, the total number of shares increases according to these ratios, but the overall value of the investment stays the same. The key point here is that a bonus issue enhances the number of shares owned while maintaining the investment's total value.

Bonus Issue	No. of shares held before bonus	Share price before Bonus issue (in ₹)	Value of Investment (in ₹)	No. of shares post Bonus	Share price after Bonus issue (in ₹)	Value of Investment (in ₹)
1:1	100	75	7,500	200	37.5	7,500
3:1	100	75	7,500	400	18.75	7,500
5:1	100	75	7,500	600	12.5	7,500

Thus it is clear that if a company you have invested in offers you a bonus issue, only the number of shares you hold will increase, but the total investment value (the amount invested by you) will remain the same before and after the issue. This happens because the share price adjusts to account for the increased number of shares, ensuring that the overall market capitalisation of the company remains constant. To put things into perspective, the adjusted share price can be seen as the final cost per share for you.

So, the bonus issue is essentially a reallocation of funds from the company's retained earnings to its share capital. While it increases the total number of shares in circulation, it does not change the company's equity value or the overall value of your investment. 

Important Dates in Bonus Issue Shares:

Similar to dividends, the following are the important dates in bonus issue shares:

• Announcement Date:

The date when the allotment of bonus shares is announced by the company.

• Record Date:

The date when the company decides to list all eligible shareholders for the bonus. 

• Ex-bonus Date:

The final day when you can purchase the company's stock to qualify for the bonus shares. If you buy the stock after the ex-date, you won't be eligible for the bonus. In India, where a T+2 rolling settlement system is used, the ex-date is two business days prior to the record date.

Advantages of Bonus Issue:

Bonus issues unlock several advantages for the company as well as investors. They are mentioned below:

1. Benefits of bonus issue for the company:

Below are the advantages that companies can reap by offering bonus issues:

• Enhancement of Share Capital:

Bonus issues enable a company to augment its share capital without incurring any extra cash outflow. By issuing additional shares to existing shareholders proportionate to their holdings, the company's share capital is effectively increased. Companies can do this without raising new investments from external sources. It is thus a cost-effective way of capital expansion for companies.

• Improved Liquidity in the Market:

When a company issues bonus shares, it increases the number of shares available for trading. This increment in share volume can enhance the liquidity of the shares in the market. Higher liquidity makes the shares more accessible and attractive to a broader base of investors, as they can buy or sell these shares with greater ease. This heightened liquidity can also lead to a more dynamic trading environment and potentially elevate the demand for the shares.

• Increase in Market Capitalisation:

Let’s not confuse this with the bonus issue itself. When a company issues a bonus, its existing market capitalisation does not change. However, the issuance of bonus shares can lead to a potential increase in the company's market capitalisation through increased opportunities to trade for the investors. And should that happen, the increase would be viewed positively by investors and the broader market.

• Enhanced Company Image and Shareholder Trust:

Distributing bonus shares can significantly improve a company's image and reinforce shareholder trust. It signals to shareholders that the company has had a financially successful period and is willing to share its prosperity. This gesture can increase shareholder loyalty and trust and foster a positive relationship between the company and its investors.

2. Benefits of bonus issue for the investors:

Below are the advantages of bonus issues for investors:

• No Cash Outflow:

Investors receive additional shares without any cash outflow. This is advantageous for those seeking to increase their stake in the company without investing more money.

• Increased Portfolio Size:

Bonus shares effectively increase the number of shares an investor holds. This can lead to a larger portfolio size, potentially increasing the overall value of the investor's holdings.

• Price Adjustment:

While the share price might decrease proportionally after a bonus issue, the adjustment is typically in line with the increased number of shares. The overall value of the investment remains the same, providing a sense of continuity.

• Tax Efficiency:

The issuance of bonus shares might have tax advantages for investors compared to receiving cash dividends. Investors may defer taxes until they sell their shares.

• Participation in Growth:

Bonus shares are often issued when a company has performed well. By receiving bonus shares, investors participate in the company's growth without having to invest additional funds.

Disadvantages of Bonus Shares:

• Disadvantages of bonus share for the company:

Below are some cons that the issuance of bonus shares exposes companies to:

• No additional income:

Bonus shares raise no money as they are offered as additional shares.

• Demotivation for investors eyeing dividend income:

If a company chooses to issue bonus shares instead of dividends, it bears more burden in the future as investors focusing on dividend income may not be too keen on increasing their investment in the company.

• Diluted earnings per share:

One potential drawback of issuing bonus shares is the impact on the earnings per share (EPS) for current shareholders. When a company issues bonus shares, the total number of shares increases, but the company's earnings do not. Consequently, these earnings are now spread over a greater number of shares, which can lead to a reduction in EPS.

• Disadvantages of bonus share for the investors:

While there isn't a significant downside for investors, those specifically seeking regular dividends might find bonus shares disappointing. However, in the long term, bonus shares could prove to be a more lucrative arrangement.

How Is a Bonus Issue Different from a Stock Split?

Understanding the differences between a bonus issue and a stock split can be a bit confusing in the beginning – they seem similar at first glance but serve different purposes once you look closer. While both lead to an increase in the number of shares an investor holds, the journey there is quite different.

Let's start with the stock split. Imagine you have a chocolate bar (your share) worth ₹100. A stock split is like breaking this bar into smaller pieces. If the company declares a stock split in a 1:10 ratio, your single ₹100 chocolate bar is now 10 smaller bars, each worth ₹10. You still have the same amount of chocolate (or value), but it's just in smaller pieces. This makes each piece (or share) more affordable and attractive to potential investors who might have found the price of a larger bar too steep.

Now, let's talk about the bonus issue, which often gets mixed up with stock splits. In a bonus issue, the company decides to reward its shareholders with extra shares, sort of like a shopkeeper giving you extra chocolates for being a loyal customer. This doesn’t involve breaking your existing shares into smaller ones. Instead, if you're holding shares of a company, they issue new ones to you, free of cost. This allotment is based on the number of shares you already own. For example, if the company announces a bonus issue of 1:1, and you own 100 shares, you get an additional 100 shares. However, unlike a stock split, these new shares come from the company’s reserves. Your slice of the pie in the company remains the same, but the size of your slice gets bigger.

Both a stock split and a bonus issue result in more shares in the market and usually a reduction in the price per share. But while a stock split is like dividing your existing assets into smaller, more manageable parts, a bonus issue feels more like receiving a gift for your investment in the company. 

Below is a quick comparison table highlighting the key differences in the two corporate actions in terms of impact on share capital, market perception, and trading price.

ASPECT	BONUS ISSUE	STOCK SPLIT
Meaning	Extra shares given to shareholders free of cost.	Divides existing outstanding shares into multiple shares.
Example	For a 4:1 bonus issue, shareholders receive four shares free for every one held.	In a 1:2 stock split, every one share held by the investor becomes two shares.
Share Capital Impact	Increases share capital, but not market capitalisation.	No change in share capital, but increases the number of shares.
Face Value	No change	Reduced in the same ratio
Company Rationale	An alternative to dividends and utilising accumulated reserves.	Increase share liquidity and affordability for more shareholders.
Market Perception	Seen as a positive sign of company health and future prospects.	Often viewed as making shares more accessible to small investors.
Trading Price Impact	Decrease in share price due to increase in the number of shares.	Decrease in share price, but no change in the value of holdings.

As you can see, each of these corporate actions stem from varying strategic reasons and have a different impact on the market perception of the stock and the market itself. However, for you as an investor, it is worthwhile to understand the difference between both.

How Is a Bonus Issue Funded?

The funding of a bonus issue can indeed be accomplished through various reserves that a company holds. The most commonly used reserves for this purpose include:

Security Premium Account:

When a company issues shares at a price above their nominal value, the excess is credited to the Security Premium Account. This reserve is often used for issuing fully paid bonus shares. When utilised for a bonus issue, the Security Premium Reserve is debited, and the Share Capital Account is credited.

Free Reserves:

Free reserves are essentially the accumulated undistributed profits of a company. These reserves are available for the company to use freely and can be allocated for issuing bonus shares. In such a case, the free reserves account is debited, and the Share Capital Account is credited, reflecting the conversion of these reserves into issued share capital.

Capital Redemption Reserve Account:

This reserve is specifically used when redeemable preference shares are redeemed. A portion equivalent to the nominal value of the redeemed shares is transferred to the Capital Redemption Reserve Account. This reserve can then be used to issue fully paid-up bonus shares to shareholders. The Capital Redemption Reserve Account is debited, and the Share Capital Account is credited during this process. It's important to note that this reserve is not used for issuing partly paid bonus shares.

In addition to these reserves, there are other possible sources for funding bonus issues, depending on the company's financial structure and the legal framework within which it operates. The company's articles of association and the relevant company laws usually govern the specifics of these processes.

Impact of Bonus Shares on Stock Prices:

Bonus issues are an attractive option for investors as they increase the number of shares owned without incurring additional expenses. However, the impact of bonus issues on share prices is not always straightforward, and it's crucial to weigh various factors before making investment decisions.

• Enhanced liquidity

:Bonus issues increase the total number of shares in circulation, potentially boosting stock liquidity. This heightened liquidity may result in increased demand for the shares, subsequently influencing the stock price.

• Dilution of earnings:

The issuance of bonus shares maintains the company's total earnings but reduces earnings per share. This dilution can lead to a decrease in stock prices, as investors might perceive the company as less profitable.

• Positive perception:

Bonus issues can positively impact how investors perceive a company. The decision to issue bonus shares may be interpreted as a favourable signal, signalling the company's confidence in its future outlook.

• Dividend impact:

Bonus issues can affect a company's dividend payouts. With total earnings remaining constant but the number of outstanding shares increasing, the dividend per share decreases. However, if future earnings are anticipated to rise, the reduction in dividends may only be temporary.

Here is an example to illustrate how the issuance of bonus shares may play out:

In 2020, Apple implemented a four-for-one bonus issue, resulting in heightened demand for Apple shares and an increase in stock prices. Similarly, in 2018, Reliance Industries declared a bonus issue of one share for every two shares held, leading to a temporary stock price dip due to earnings dilution. However, the stock price recovered as investors perceived the bonus issue as a positive signal.

Wrapping Up

Bonus shares are a form of corporate benefit that companies extend to existing shareholders. 

While bonus shares don't immediately enhance shareholder wealth, they play a significant role in the long-term sustainability and competitiveness of the company. The issuance of bonus shares can also influence market dynamics. Often, the announcement of bonus shares is perceived positively by investors, who may see it as an indication of the company's strong performance and potential for growth. This perception can positively impact stock prices and market sentiment.

Thus, the distribution of bonus shares is a strategic decision by a company to reinforce its relationship with its investors. It reflects a policy of redistributing the company's accumulated profits among its shareholders to foster loyalty and trust.