What is Bonus Shares?

Bonus Shares

Even in the severely contracted economy due to the pandemic COVID-19, Various companies like Hatsun Agro Products, Infosys Ltd, Vishal Fabrics, Global Education, etc. declared bonus shares in the year 2020. Always Bonus issues create a wave of excitement in the stock market. It normally steers bull run.

This article provides detailed information on basic concepts of Bonus shares – meaning, types, important dates, etc. Also, it explains the merits and demerits from issuing company and investors’ perspective. Let’s deep delve into the concept.

Dividends are rewards paid to the shareholder for his investment or shareholding in the firm. It could be paid in the form of Cash, Bonus shares, Property, Scrip, etc. Popularly followed practices In India are Cash dividends and Bonus shares.

What are Bonus Shares?

Bonus shares are additional shares given to the current/existing shareholders without any additional cost, based upon the number of shares held by them.

These are issued out of the company’s accumulated earnings or reserves which are not maintained for other expansion purposes but to issue dividends and are converted into shares. Here reserves are getting capitalized to shares. These are free shares to the investors and they need not pay anything to acquire them.

An issue of bonus shares is referred to as a bonus issue.

Why companies issue Bonus Shares?

  • Companies with accumulated reserves, which strive to reward investors but due to paucity of funds unable to pay dividends in cash, issues bonus shares encouraging more retail participation and providing more liquidity to the investment.
  • It increases the paid-up capital and equity base of the company and enhances the image or goodwill of the firm in the eyes of investors. 
  • Bonus issue increases the capital base, but the however value of the firm and the holding pattern remains constant.

How reserves are capitalized to issue Bonus shares?

For Example:  Let’s assume that X Company is planning to issue bonus shares which has 5,000 Equity Shares of 10 each and reserves of 50,000. From which it is planning to issue the bonus shares of the same denomination (Equity share of 10 each).

Then,

No of shares to be offered = Reserves / Par Value per share

= 50,000/ 10 per share

= 5,000 shares

If the company is issuing 5,000 shares, then the Bonus ratio will be 1:1, nothing but each current shareholder will get 1 share as a bonus share for each share held by him in the company.

What are the types of bonus shares?

  • Fully paid-up bonus shares: When bonus shares are distributed at no additional cost to the par value of the share, in proportion to the holdings of the company, it is called fully paid-up bonus shares.
  • Partly paid-up bonus shares: When bonus issues are applied to convert partly paid-up shares to fully paid-up shares to the par value, without expecting shareholders to pay the further sum, it is called partly paid shares.

 Few concepts required to understand the bonus issue is explained as follows:

Bonus ratio – The ratio in which bonus shares are issued to the current shareholders in the proportion of their existing shareholding pattern is called the Bonus ratio.

Recently Astral Poly Technik Ltd has issued bonus shares in the ratio of 1:3, nothing but for every 3 shares held by an investor, one share will be issued. Now the question arises who are eligible to receive bonus shares. The answer lies in two dates to be noted: 

Record date  – It is the date set by the company, by that date investor should have owned shares, to be eligible to receive bonus shares.

Cum bonus – The date after the announcement of bonus but before the record date is called cum bonus.

Ex-Date – It is usually set one business day before the record date, as in India we follow the T+2 rolling settlement cycle for delivery of shares.

Let’s understand clearly with the help of an example of Hatsun Agro Products Ltd: 

Hatsun Agro bonus shares
Hatsun Agro bonus shares. Source: moneycontrol.com

The Bonus shares were announced on 19th October 2020, which is the Announcement date. 10th December 2020 is the Record date set within which the investor should have held shares of the company to become eligible for bonus allotment.

The time gap between 19th October 2020 and 10th December 2020 is termed as Cum Bonus and last but important to note 9th December 2020 is the Ex-bonus date.

If you acquire a share on 9th December 2020, shares would not have been credited to your account on the record date. Therefore, acquiring shares a day prior to the Ex-Bonus date is necessary to become eligible for bonus shares.

For More Details Visit: www.moneycontrol.com

What happens after bonus shares are issued?

Normally, after bonus shares are issued, the prices of shares would fall in the proportion of the bonus issue. If Happy and Sad Ltd.’s share price is 200 cum bonus and bonus ratio is 1:1, then the share price would be adjusted to 100 per share.

But generally, bonus shares are a ray of hope and a sign of the company’s strong fundamentals’, a booster of investors’ confidence, and hence demand and supply factors keep share prices high.

Why share price falls after bonus shares are issued?

Bonus issue reduces the reserves and increases the paid-up capital of the firm. But the fact is the absolute book value of the company remains constant and does not change at all.

As the number of outstanding shares has increased, the book value per share decreases. And for valuation purposes, the share price is adjusted on a proportion basis.

Now we have come to the last part of the article discussing on merits and demerits of bonus shares to the company and investors.

Company’s perspective

Merits

Demerits

It boosts investors’ confidence in the company and increases the share price.

There is no money income actually distributed to shareholders as a return on investment.

It helps the company in retaining cash reserves, as well as fulfilling the objective of dividend distribution. And therefore, liquidity position remains unaffected also increases the share price. It helps in reinvesting cash for business purposes.

Bonus issue increases the number of shares outstanding and reduces future EPS and might affect the company’s goodwill.

It is the sign of profitability and growth of the company, indicating strong fundamentals.

It doesn’t affect the Net profit of the company by just issue of bonus shares.

An increase in the number of outstanding shares through bonus issues changes the perception of the scale of operations of the business.

Investors expecting dividend income from the company may remain unsatisfied and it may become a blunt tool in maximizing shareholders’ wealth.

It unalters the shareholding pattern and helps management in retaining the existing control.

It avoids a new breed of investors, new thoughts, new ideas coming into the business and leads to a kind of stagnation.

After the bonus issue, paid-up capital increases to the total capital employed, this streamlines the capital structure of the firm.

High equity in the capital structure may reduce leverage benefits to the shareholders.



Investors perspective

Merits

Demerits

Bonus shares are free shares to investors, it increases the number of shares held by them and provides more scope for retail participation.

When bonus shares are made, share prices are reduced proportionately, this does not increase the number of total holdings in the company.

Usually, under normal circumstances, Bonus shares enhance the goodwill or brand image of the company, increasing share prices and ultimately maximizing the wealth of shareholders.

Issue of dividend in the form of shares, but not in cash may dissatisfy expectant investors.

More shares entitle shareholders to receive higher dividend income on shares in the future than before.

Dividend yield may decline in the future, creating a dilemma in the minds of investors. It leads to unnecessary speculation.

Closing Thoughts

Since there are no fundamental changes that occur in a company by issuing bonus shares, it doesn’t come with much value as most investors think it is free shares.

In the easy term if the no. of shares held by you will become double then the earning per share (EPS) will reduce by half because no. of shares are going to be double. Fundamentally there will be no changes occur in the Net profit of the company.

Learn EPS and Important Financial Ratios Every Investor should know.

Even though the bonus issue reduces the share prices proportionately, share prices, in the long run, are basically dependant on fundamentals’, investment avenues, growth prospects, and investors’ confidence in the company. 

Data of few companies are used in the article for learning purposes and not intended to provide any investment advice. You are requested to make your own analysis before investing, and the authors or website does not own any liability.

Ramya N & Chaitra Karanth
Ramya N & Chaitra Karanth both are Assistant Professor at NMKRV College For Women. Ramya N has 7 years of experience in teaching. Chaitra Karanth is skilled in Microsoft Word, Public Speaking, Teamwork, and Microsoft Excel. Strong accounting professional with a Master of Finance and Accounting (M.F.A.) focused in Accounting and Finance.