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Bonus shares, a common corporate strategy, hold a pivotal role in shaping the dynamics of a company and influencing shareholder interests. Understanding the nuances of bonus shares is essential for investors seeking comprehensive insights into corporate finance. In this blog, we will delve into the multifaceted realm of bonus shares, exploring their definition, various types, and the associated advantages and disadvantages. Join us on this informative journey as we break down the key aspects of bonus shares and examine their impact on both companies and shareholders.
Table of Contents
Defining Bonus Shares
Bonus shares are an additional number of shares given by the company to its existing shareholders as a ‘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 issues, scrip issues, or capitalisation issues.
- A company is eligible to issue bonus shares to its shareholders only if it has generated substantial profits or possesses significant free reserves that cannot be allocated for any specific purpose and can be distributed as dividends.
- 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.
Important Terms to Remember
There are a few unique terms associated with bonus shares.
- 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 two 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 the 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 ex-bonus.
Types of 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:
- Profit and loss account
- Capital reserves
- Capital redemption reserves
- Security premium account
Partly-Paid Bonus Shares
- A partly paid share is only partially paid compared to the full issue price.
- Investors can purchase partly paid shares without paying the total issue price upfront.
- The remaining amounts for partly paid shares can be paid in instalments when the company issues a call.
- Partly paid-up bonus shares occur when the bonus is applied to partly paid shares, converting them into fully paid shares without calling out the uncalled amount through profit capitalisation.
- 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 them 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.
- 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.
A bonus share issue impacts the earnings 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, give 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.
- The issue of bonus shares benefits companies to get themselves out of situations where they are not able to or simply do 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 to 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 earnings per share falls.
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 minimised.
- When a company keeps 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 do bonus issues strengthen a company’s equity base, but they also increase retail participation in its shares. An investor, you stand to gain if the company announces a bonus issue. Before starting to invest in company shares, you must mandatorily have a Demat Account with your trusted financial partner, like Share India.
Conclusion
A comprehensive understanding of bonus shares is vital for investors aiming to maximise returns and engage in company growth. Bonus shares not only serve as a means for companies to reward shareholders but also aid in capital retention. As an investor, staying informed about the implications of bonus shares can offer strategic advantages. For further exploration and application of trading strategies, consider leveraging the features of the Share India trading app.