We Indians are very fond of freebies, whether it is the "Buy one Get one" sale of cookies or the Diwali Bonus that every employee eagerly waits for.
Getting extra for the same amount is like a blessing in disguise when you know that it may earn multiple folds in future. As a new-age Indian investor you should be aware of all the key concepts and fundamentals of the stock market which can help you gain the maximum returns on your investment journey.
One such crucial aspect is knowing about corporate actions (check out our previous blog to understand how corporate actions impact their stock prices), which are the decisions taken by the companies listed on the stock exchange. These can be issuing dividends, rights, split stocks and bonus shares.
In this blog, you will learn about the corporate action known as Bonus Shares.
Understanding Bonus Shares:
Bonus shares are an additional number of shares given by the company to its existing shareholders as “BONUS” instead of or in addition to paying a dividend to its shareholders as a means of distributing gains from business..
Bonus shares are also known as Bonus Issue, Scrip Issue, or Capitalisation Issue.
Only a company has the right to issue bonus shares to their shareholders, which has earned massive profit or large free reserves that cannot be utilized for any particular purpose and can be distributed as dividends. However, these bonus shares are given to the shareholders according to their existing stake in the company.
For instance, if a company notifies 1:2 bonus issue, the shareholders are entitled to receive one additional share for two existing shares they hold. So, a shareholder with 200 existing shares will now have an additional 100 shares, bringing the total number to 300.
Upon a bonus issue of shares, the dividend per share decreases as there is an increase in the number of shares. The share value also decreases upon a bonus issue, keeping intact the investment value of the shareholder as the number of shares owned by a shareholder is higher than before.
There are few uniques terms associated with bonus shares, let’s learn about them one by one:
Record Date: The record date is the cut-off date decided by the company to be eligible for bonus shares. All shareholders who have shares in their Demat account on the record date will be eligible to receive bonus shares from the company.
Ex-Date: The ex-date is 2 trading days before the record date. Here an investor has to buy the shares at least one day before the ex-date to become eligible for the bonus shares.
Cum-Bonus: The eligible shares between the date of announcement of bonus issue and the record date are known as Cum-Bonus.
Ex-Bonus: . On and after the ex-date, the shares if bought are no longer eligible to receive the bonus and are called as ex-bonus.
Types of Bonus Shares:
There are two different types of bonus shares as follows:
- Fully paid bonus shares
- Partly-paid up bonus shares
Fully Paid Bonus Shares
Fully paid bonus shares are those shares that are distributed at no extra cost in the proportion of the investors holding in the company.
These types of bonus shares can be issued from the following sources:
1) Profit and loss account 2) Capital reserves 3) Capital redemption reserves 4) Security premium account
Partly-Paid Up Bonus Shares
Before understanding partly-paid up bonus shares, let’s understand what a partly-paid share is?
A partly paid share is a share in a company that is only partially paid compared to the full issue price. It means that the investor can buy partly paid shares without paying the total issue price.
However, the remaining amount for partly paid shares can be paid in installments when the company makes calls.
So when the bonus is applied in the partly-paid shares and converted into fully paid shares without calling out the uncalled amount through profit capitalization, it is called partly-paid up bonus shares. However, unlike fully-paid up bonus shares, partly paid-up bonus shares cannot be issued through a capital redemption reserve account or security account.
Eligibility For Bonus Shares:
- Shareholders who own the company's shares before the ex-date and record date are eligible to receive bonus shares from the company.
- In India, the T+2 rolling system is set for the delivery of the shares, wherein the record date is two trading days beyond the ex-date.
- Shareholders must purchase shares before the ex-date because if they purchase on the ex-date, the company will not give the ownership of shares, and therefore, they will not be eligible to receive bonus shares.
- Once a new ISIN (International Securities Identification Number) is allotted for the bonus shares, they get credited to the shareholder's account within 15 days of time. Subsequently they are credited to the regular ISIN (and tradeable) after necessary permissions from the exchanges.
Implications of bonus issue:
- The bonus share issue is a corporate action to revamp the existing reserves of a company. It brings the employed capital of the company in sync with the issued capital. If a company makes a profit, it increases its employed capital. This surplus is distributed by increasing issued shares, also known as issued capital.
- A bonus share issue does not impact a company’s net assets as the action does not involve any cash flow. It simply means that the number of shares issued by the company called share capital has increased.
- Bonus share issue impacts the Earning per Share (EPS), calculated by dividing a company's net profit by the number of owned shares. However, a decrease in EPS is compensated in the long term by a corresponding increase in the number of owned shares.
- Typically, a bonus share issue underlines the sound financial health of the company. It reflects that the company is strong enough to issue additional equities and has made profits.
Advantages of Bonus Shares:
From Investor's Point of View
- Investors do not have to pay any tax while receiving bonus shares from the company.
- Bonus shares are considered beneficial for long-term shareholders of the company looking to multiply their investment.
- Bonus shares are free of cost to shareholders as they are issued by the company, which increases the outstanding shares of an investor in the company and enhances the liquidity of the stock.
- Bonus shares help build the trust of an investor in the company's business and operations because they have invested in the company and, in turn, gives capital to the investor.
From Company's Point of View
- The issue of bonus shares enhances the company's value and increases positions and image in the market, gaining the trust of existing shareholders and attracting several small investors to be a part of the stock market.
- The companies have more free-floating shares with the issue of bonus shares in the market.
- Issue of Bonus shares benefits companies to get themselves out of the situation where they are not able to or simply not prefer to pay cash dividends to their shareholders.
Disadvantages of Bonus Shares:
From Investor’s Point of View
There is not much of a disadvantage of owning the bonus shares from an investor’s point of view. However, they should know about receiving bonus shares because the profit will remain the same, but the number of shares will be increased as the earning per share will fall.
From Company’s Point of View
- The company does not receive any cash while issuing bonus shares. As a result, the ability to raise money by following an offering is minimized.
- When a company keeps on issuing bonus shares instead of paying dividends, the cost of the bonus issued keeps adding up over the years.
A company can issue bonus shares to its shareholders to distribute its accumulated earnings. Not only does bonus issues strengthen a company’s equity base, but they also increase retail participation in its shares. As an investor, you stand to gain if the company announces a bonus issue. Before starting to invest in company shares, you must mandatorily have