21 Jan 2019 04:26am IST
Neetant D Sinai Shirodkar
Getting basics right is of paramount importance in any sphere of life, the same holds true while investing in the capital markets. Knowledge of fundamentals not only helps in taking correct decisions while investing but also clears misconceptions that one may hold out of ignorance. So let’s get started with another concept of investing in stock markets, which should help you to accelerate your returns. The concept I am dealing with today is that of Bonus Shares and Stock Split.
The name bonus has a notion that something is being given to us extra. It denotes, we are getting something extra without paying anything extra.Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares. The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
For instance, if Ravi has 100 shares of Hindustan Lever Limited and the current market price is Rs 1500 per share. The company informs him that they will be giving him 1 share bonus on every 1 share that he has. That means they will be giving him 1:1 bonus issue. But it does not change the financials of the company. The company simply adds the same number of shares in their books extra. But the companies profits have not changed, the balance sheet has not changed, in fact, nothing else is changed. So after the 1:1 bonus issue, the company’s share price becomes half at Rs 1500 / 2 = Rs 750.
Ravi previously has 100 shares of Rs 1500 each. His total share value was Rs 1500 x 100 = Rs 1,50,000. After issuing the bonus, Ravi now has 200 shares of Rs 750 each. So now also his total share value is Rs 750 x 200 = Rs 1,50,000. That means that even after the bonus is declared and given no increase or decrease happens in total share price. Simple Ravi now has double the number of shares of half value.
Why do companies issue Bonus Shares?
Companies issue bonus shares to encourage retail participation and increase their equity base. When price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. As seen in the example above increase in the number of shares reduces the price per share. But the overall capital remains the same even if bonus shares are declared.
A stock splits is a change (increase or decrease) in a number of outstanding shares of a company by proportionately changing (decreasing or increasing) the stock price so that overall Market Capitalisation remains the same. Stock Split 2 for 1 essentially means that there will now be two shares instead of 1 share. For example, if there were 100 shares and the issued price was Rs 10, with the market capitalization of 100 x Rs 10 = Rs 1,000. If the company splits for 2 for 1, then the total number of shares will double to 200 shares. The effective share price will be Rs 1000/200 (Market cap/shares) = Rs 5 per share.
How is Stock Split different from Bonus shares?
The bonus issue is similar to stock splits in a way that share price decreases and the number of shares increase in both cases. In case of bonus issue the company gives additional shares to its shareholders from its free reserves instead of issuing dividends. However in case of a share split, there is no such fresh issue, it is just manipulation of already issued capital.
Refer to this table for more understanding.
From anaccounting perspective, in case of bonus issue, as shown above, the company issues fresh shares at same face value and transfers free reserve capital to issued share capital. In case of stock splits, free reserves and issued capital remain same. Among bonus issue and stock splits, bonus issue may be perceived as more positive as the company is issuing more shares to shareholders from its free reserves. This can be perceived as signaling from management to investors that they are confident of more growth in future.
So the next time you invest I hope you will be better off with two more concepts unearthed today, shall be back with more such information to help you grow with your investments fundamentally.