Introduction
Bonus shares are an alluring topic in the domain of corporate finance and financial markets. This field of shares is generally issued to the existing shareholders properly based on their current holding and at that rate. It is a useful way for the companies to reward shareholders by using up accumulated profits without paying out real cash. In this article, we will look in detail about bonus shares and talk on why are they meaningful, how the issuance of a share works out when it’s through bonus issue, and what is their relevance concerning shareholders as well as the market along with real examples.
What Are Bonus Shares
These shares are generated from the company’s accumulated profits or free reserves. In simplest term, Bonus shares are actually the reward of being a shareholder for long period.
Key Characteristics:
- No Cash Flow: Issuance of Bonus Shares does not involve outflow of any cash from the company.
- Allocation is Proportional: The bonus shares are allocated in the proportion of your present holding.
- Share Price Change: Upon issuance, the shares generally increase by selling new stock and creating more outstanding values.
- Shareholders Equity Neutral: Despite the increase in number of shares, a shareholder`s total equity value remains unchanged.
Why Do Companies Issue Bonus Shares?
1. Rewarding Shareholders:
It is the method to reward their shareholder by issuing bonus shares. This in turn increases the number of shares owned by shareholders (and ensures there are no costs for this action), demonstrating that management believes its profitability and growth prospects post-rights issue.
2. Signaling Effect:
It also gives positive indication to the market that company is in a good financial position and it has enough reserves to issue bonus shares. This would improve investor confidence and lead to an increase in the company’s stock price.
3. Enhancing Liquidity:
This will not only help make the stock more liquid but also easier to buy for shareholders.
4. Optimal Share Price:
Bonus shares might be issued so that the share price looks more attractive to retail investors. The lower share price can lead to a higher number of investors, therefore more demand for the stock.
The Process of Issuing Bonus Shares
Step 1: Board Approval:
The process commences with the resolution of board passing for issuance of Bonus Shares by a Company. This resolution will however specify the ratio of bonus issue (like 1:1, 2:1 etc.)
Step 2: Shareholder Approval:
If it is passed the board resolution comes up before a general meeting of shareholders for approval. Approval is achieved through a simple majority vote.
Step 3: Record Date:
Record date is determined for the purpose of entitlement to bonus shares. The bonus shares will be available only to the shareholders who are on the company books as of 4 August, being record date.
Step 4: Issuance:
Finally, after all necessary approvals are obtained, the bonus shares get issued to eligible shareholders. The shares are updated to shareholders’ demat accounts and the total equity of quantum rises.
Impact of Bonus Shares on Shareholders
1. Increase in Number of Shares:
Bonus shares are provided to shareholders in the form of new shares with respect to bonus ratio. For instance, it doubles the carrying of every shareholder in a 1:1 bonus issue.
2. Adjustment in Share Price:
The afterward comes from the Market price of share which sinks (adjust downward) to accommodate new shares. So, if a company declares 1:1 bonus will issue than suppose price of that share is Rs.200 before issuing Bonus so after issuance it might be adjusted to more or less around Rs.100
3. Dividend Impact:
Although the overall dividend may be fixed, at higher shares outstanding…so will your total investment amount – hence making it irrelevant for you. For instance, if a company declares an overall dividend of INR 1,000 and the original number of shares was 100 then the equivalent amount per share will be INR 10. Post-bonus 1:1, number of shares get doubled to 200 so dividend per share becomes INR5.
4. Tax Implications:
Issue period of bonus shares are not applicable for taxation. But they do affect the cost base of shares for CGT purposes. Its share price adjusts in accordance to the bonus and drops by same proportion as well (assuming this is a dividend paying company) but simply because it issues shares without charging anything does not mean you are getting something for nothing – once they issue more shares, naturally your ownership stake has automatically been shaved off unless somehow those transferred new equity were free.
Impact of Bonus Shares on the Market
1. Market Perception:
Introduction of bonus shares is considered as noted positively in the market because with this example, it displays about evergreen and healthy financial conditions. At least in the short term, this can push up stock prices as investor sentiment recovers.
2. Liquidity Enhancement:
More shares available in the market can crowdsource liquidity, resulting in enhanced stock tradability for investors. This would ultimately improve price discovery and dampen volatility
3. Market Cap Adjusted:
Although the number of shares goes up and down, as does the price per share but if no other outside forces are changing to affect those factors, then it’s canceled out by market capitalization.
Examples of Bonus Share Issuances
Example 1: Infosys
If we go by history, Infosys is one of the leading ITs to announce bonus shares. In 2018, Infosys declared a bonus issue at an exchange ratio of one to one which meant that for every share held by the shareholders they were given another free. This change was viewed favorably and sent a strong signal to the market that investors should have continued confidence in their outlook for future growth.
Example 2: Reliance Industries
Reliance Industries also had issued bonus shares back in 2017, which was again a large player of the market. The company came with 1:1 bonus issue, which greatly benefited the concern on Dalal street. The transaction is also reflective of our strong financial performance and continued commitment to return cash to shareholders.
Advantages and Disadvantages of Bonus Shares
Advantages
Reward for Shareholders: Bonus shares are a reward for the existing shareholders by increasing their stake in the company and that too without any additional investment.
Positive Market Signal: A bonus share issue is generally considered a good indication of the company’s sound financial health and high growth potential, which eventually attracts investors.
Increased Liquidity: Being one of the essential functions that capital markets do is to facilitate buying and selling in shares, a greater number of shares available for trade can lead to increased liquidity.
Attractive Share Price: A Bonus Share Issue Reduces the share price and makes its more attractive to a broader investing audience.
Disadvantages
Dilution Earning Per Share (EPS): Increase in share becomes unfavorable potentially for short-term by diluting EPS.
No Immediate Cash Benefit: Bonus shares do not bring about the immediate cash benefits to shareholders as dividends.
Administrative Costs: The cost of issuing bonus shares in terms of administrative and regulatory compliance can be considerable.
Conclusion
There are few more fascinating financial instruments than bonus shares – a way of rewarding shareholders and giving them an insight into the strength of company balance sheets. While they may not offer cash benefits directly, stock splits can raise the count of shares owned by individual investors and boost market trading fluidity as well. These bonus shares are always considered as a very good news by the market and they also consider it that company will/group costumers are/confident on its future earnings. Even then, the name of shareholder should be familiar with potential dilution to EPS and Nil direct cash benefit in short term. Knowledge of bonus shares and the way they work can inform investors to save from making mistakes when choosing the right share that could bring more value on their investments.
Why companies issue the bonus shares?
Bonus shares are the shares of a company that it issues to reward its shareholders without paying in cash. This shows how profitable the company is and its belief in long-term profits. Bonus shares additionally, increase the circulation of stocks and in order that give you liquidity which as an immediate effect lowering down percentage costs making it extra lower priced for retail buyers.
How are bonus shares issued?
Shareholder approval follows if a majority of the board supports the process. To make matters more official, a record date is announced to ascertain those shareholders who would be eligible. The bonus shares are then credited to demat accounts of shareholders in the ratio approved (for example 1:1 bonus issue)