Reasons for issuing bonus shares
Issuing bonus shares is a strategy that companies employ for multiple financial and strategic reasons. Here are the primary reasons why companies decide to issue bonus shares:
1. Capitalisation of reserves
Bonus shares allow companies to convert accumulated earnings from reserve accounts into share capital, distributed among existing shareholders relative to their current holdings.
2. Increase in share liquidity
Issuing bonus shares enhances market liquidity by increasing the number of shares available, making it easier for smaller investors to trade.
3. Affirmation of confidence
This move can signal the management's belief in the company's long-term profitability and robust health.
4. Adjustment of share price
The issuance of bonus shares typically lowers the share price, making the stock more accessible to a wider range of investors without affecting the overall market capitalisation.
5. Earnings Per Share (EPS) adjustment
While EPS may initially decrease, the reduced share price can attract more investors, potentially increasing future earnings.
6. Encouragement of retail participation
A lower share price post-issuance can encourage more retail investors to buy shares, diversifying the investor base and stabilising the stock price.
7. Psychological impact
Issuing bonus shares can create a positive perception of the stock and reinforce shareholder loyalty.
Overall, issuing bonus shares utilises internal resources efficiently, optimises stock market performance, and strengthens shareholder relations while promoting broader investor support.
Additional read - What are preference shares
Eligibility for allotment of bonus shares
Shareholders who own company shares on the record date are eligible to receive the bonus shares. In this context, there are two important dates that you should be aware of — the record date and the ex-date.
The record date is when the company checks its records to identify eligible shareholders for its bonus issue. The ex-date is the date by which you should purchase the company’s shares if you want to be a registered shareholder by the record date. Since the settlement cycle in India follows a T+1 schedule, the ex-date is generally one or two trading days before the record date.
Let us look at an example to understand how eligibility for a bonus issue of shares works.
Suppose a company announces a bonus issue on April 5th and sets the record date as April 26th. This means the ex-date is April 25th. So, you must purchase shares in the company by April 25th if you want the advantage of its bonus shares. This way, you will appear as a registered shareholder in the company’s records in T+1 days, i.e. by April 26th, which is the record date.
Why do companies issue bonus shares?
Companies may issue bonus shares for various reasons. They include:
- Lowering the current price per share.
- Promoting liquidity for its shares in the secondary market.
- Improving retail investor participation.
- An alternative to dividend payments to shareholders.
- Boosting the company’s reputation in the market.
Advantages of bonus shares
Bonus shares are beneficial to shareholders in many ways. The advantages of bonus shares include the following:
- Bonus shares give investors more shares, increasing their investment and making it easier to buy and sell stocks.
- Those who get bonus shares don't have to worry about paying taxes because there aren't any.
- They are great for people who want to invest for a long time because it helps them make more money over a wider range.
- When companies pay out dividends, people who have bonus shares get more money because they own more shares..
- Having bonus shares makes investors trust the company more because it can grow without spending extra money.
Disadvantages of bonus shares
While issuing bonus shares offers benefits, it also presents some disadvantages from both the investor's and the company’s perspectives:
From an investor's point of view
- Dilution of Earnings Per Share (EPS): Receipt of bonus shares increases the number of shares held but doesn't change the total profits, resulting in a reduced EPS. This lower EPS can negatively affect the valuation perceived by potential investors.
From a company’s point of view
- No cash inflow: Issuing bonus shares does not generate cash as they are funded from the company's reserves. This method redistributes retained earnings into share capital without adding new funds, limiting the company's capacity to invest in new projects or reduce debt.
- Reduced flexibility for future capital raises: With more shares in circulation, future capital raising efforts may require issuing more shares to raise equivalent funds, potentially diluting the stock further and possibly lowering the price.
- Potential misinterpretation of financial health: Regularly issuing bonus shares rather than dividends might suggest to the market that the company lacks sufficient cash for dividend payouts, which could lead to concerns about its liquidity and cash flow.
- Increasing costs over time: The administrative and regulatory costs associated with issuing bonus shares can accumulate and managing a complex share structure can be administratively burdensome.
Conditions for the issue of bonus shares
For a successful bonus issue, the following conditions need to be met by the company:
- The company’s Articles of Association (AoA) must authorise a bonus issue.
- If the AoA does not sanction the issue of bonus shares, a special resolution must be passed at the company’s general meeting.
- The company’s Board of Directors must approve of the issue.
- The shareholders must also sanction the issue.
- The total share capital of the company, including the bonus issue, must be less than or equal to its authorised capital.
How bonus share is different from stock split?
Bonus shares and stock splits are both corporate actions that increase the number of shares outstanding, but they differ in their mechanics and implications for shareholders.
Aspect
|
Bonus shares
|
Stock splits
|
Nature of issuance
|
Issued free of charge to existing shareholders.
|
Existing shares divided into multiple shares.
|
Purpose
|
Improve liquidity, reward shareholders.
|
Reduce share price, increase affordability.
|
Accounting treatment
|
Capitalised from retained earnings or reserves.
|
No impact on financial accounts.
|
Impact on share price
|
Does not directly affect share price.
|
Adjusts proportionately, lowering price per share.
|
Conclusion
You can keep up with the news to track all upcoming bonus issues and purchase shares of promising companies before the ex-date. This will help you diversify your portfolio and multiply your investments in a cost-effective manner.
Check out other interesting articles
