Businesses often reward their shareholders through various means, including dividends or additional shares. Bonus shares and stock splits are the two common methods used for this purpose. Both mechanisms aim to enhance shareholder value but operate in different ways.
In this article, we will look at the differences between a stock split and bonus shares, understand the concept of bonus share vs. stock split, and explore how each strategy impacts shareholders and the overall dynamics of a business.
Understanding bonus issues
Usually, when a business issues additional shares to its existing shareholders in a predetermined proportion, it is known as a bonus issue. For instance, in a 3:1 bonus issue, shareholders receive three additional shares for each share they currently hold.
For example, if an investor owns 100 shares of a certain large-cap stock, with a 3:1 bonus issue, they would receive 300 additional shares (3 * 100), resulting in 400 shares (100 initial shares + 300 additional shares).
Understanding stock splits
When the number of shares held by investors is multiplied without altering the overall value of a business, it results in a stock split. The difference between a stock split and bonus issues is that in a bonus issue, the existing shareholders receive additional shares as a reward. Such actions ensure that the nominal value of shares while adjusting their quantity is maintained.
In a stock split, the trading price of individual shares is lowered, which allows the company to maintain its market cap while increasing the number of shares outstanding.
For investors, understanding the difference between bonus shares and a stock split helps them make strategic decisions concerning their investments.
Bonus share vs stock split - How do they affect share prices?
In a bonus issue, the stock price adjusts as per the additional shares issued. Let us assume a company announces a bonus issue at a ratio of 2:1, and the stock price before the issue stands at Rs. 200. Post the bonus issue, the total share count would double. Therefore, if an investor initially held 100 shares, they would now hold 300 shares, which would result in a revised stock price of approximately Rs. 66.5.
This adjustment ensures that the proportional value of the shares post-bonus issue is maintained. However, supposing the stock price falls in proportion to the bonus issue, for a 1:1 ratio, the price would halve to approximately Rs. 33.
The difference between bonus shares and a stock split is that in a stock split, the share price halves in the specified ratio. For instance, in a 2:1 stock split scenario with a pre-split price of Rs. 80 and a total share count of 200 shares, the post-split share count would be 400 shares, resulting in a new price of Rs. 40.
Similarly, the face value, which represents the value of shares listed in the records of a business, adjusts in the same ratio during a stock split, which ensures consistency with the nominal worth of the split shares. For example, if the pre-split face value was Rs. 20, it would reduce to Rs. 10 per share after the split.
Understanding these aspects is important for investors as they can heavily affect investment decisions and overall portfolio performance.
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Understanding the company’s rationale
Another key difference between a stock split and bonus issues is that many companies use a bonus issue as an alternative to dividends. Dividends involve distributing extra money to shareholders from net profits. However, a bonus issue entails granting additional shares to shareholders. This action improves the share capital of a company and attracts investors. Moreover, bonus issues usually serve as a strategic tool to strengthen retail participation, particularly when a high trading price of a stock poses challenges for individual investors.
Conversely, a company may choose a stock split to decrease the price of its shares, thereby making them accessible to a broader range of investors. Overall, while a bonus issue expands the equity base of a company and increases liquidity, a stock split helps lower share prices and improve accessibility to investors, eventually fostering greater market participation.
How does the share split vs bonus issue affect you as an investor?
Bonus shares and stock split are methods companies use to reward their shareholders without charging any form of additional payment. Here, we list the main points regarding bonus shares and a stock split so you can understand how they may affect you as a shareholder:
Meaning
- Bonus issue: These are the additional shares offered to shareholders free of cost.
- Stock split: This results in dividing the company's existing outstanding shares into multiple shares.
Example
- Bonus issue: In a 2:1 bonus issue scenario, shareholders receive two shares free for every one share held. Thus, for 10 shares, investors will receive 30 (2 * 10 + 10) shares in total.
- Stock split: In a 2:1 stock split ratio scenario, every share held by a shareholder becomes two shares. For every 50 shares held, the share count increases to 100 shares.
Face value
- Bonus issue: No change occurs in terms of face value.
- Stock split: Face value reduces in the same ratio as the split.
Company rationale
- Bonus issue: This is considered an alternative to dividends and a means to distribute accumulated reserves to shareholders.
- Stock split: This is aimed at increasing share liquidity, reducing share price, and making it more affordable for a larger spectrum of investors.
Also read: Invest in US stocks from India
Final thoughts
Bonus shares and a stock split increase shares and decrease market value, but only stock splits affect face value. Bonus issues signal extra reserves transferred to share capital, while stock splits make costly shares available to more investors. Thus, it is crucial for you to thoroughly understand these financial concepts to make the most out of your investments.
