An Overview of Bonus Shares

We have often heard the term ‘Bonus Shares’ distributed as a free shares with no cost! Is it like that? Read this blog to know completely about the bonus shares!

What are Bonus Shares?

Bonus shares are free shares given by the company to its existing shareholders in a specific ratio. The specific ratio can be decided by the company, for example it can be 3:1 (i.e. 3 bonus shares for every 1 share held).

We are aware about the fact that shares are traded on daily basis. So, one might have question as to how does a company know who is its "existing shareholders"? Since, it’s quite possible that an individual holding share today may sell and will not be holding it tomorrow. So, what are the eligibility criteria for a shareholder to participate in bonus shares?

To ascertain whether a shareholder is eligible to receive the company's bonus shares, the company establishes a Record Date. This date helps in determining who is qualified to receive the bonanza. Every holder on that particular date is considered as an existing shareholder for Bonus shares.

One also has to consider the impact of bonus shares with respect to its investment value and proportionate holding.

Investment Value - Theoretically, the share price falls in the same proportion that the bonus shares are issued. There are no free lunches. For example, if you are holding one share of INR 1000 of ABC Ltd. and the company announces bonus in the ratio 1:1.

Net worth (Before issue of bonus): 1 share x INR 1000 per share = INR 1000.

Net worth (After issue of bonus): 2 share x INR 500 per share = INR 1000.

Hence, the share price in the above instance has fallen in the same proportion INR 500 after the bonus issue when the number of shares increases.

Percentage Holding - Theoretically, this also doesn't change as all of the existing shareholders get bonus shares in proportion of their existing holding. Thus, proportionately the shareholding pattern remains the same.

Example of the company who has announced bonus shares

Long term investments are the best for capital formation. There are various companies like WIPRO Ltd., Infosys Ltd., etc. who have increased the investor's capital through issue of bonus shares.

For instance, if an investor had bought 100 shares of Infosys ltd. for INR 9,500 in 1993, it could have turned the wealth of an investor into crore. Warren Buffet once said that buy shares thinking as if you will hold it forever. Infosys ltd. came with its IPO in the year 1993 for INR 95/share.

Initially investment of INR 9,500 in the year 1993 is worth multiple thousand today having a market value of investments INR 71,680,000 (approximately).

What are corporate actions? How does it help investors?

Corporate Actions involves actions like bonus shares, right issue, merger, etc. which has a material impact on the company and its shareholders. Investors should have good understanding of corporate action if they want to participate in such activity. Understanding such corporate action can help an investor determine whether to buy or sell the shares.

What are the parameters to find the possibility of a company that might issue bonus shares?

There are different parameters to find the probable company capable to issue bonus shares -

• The company which has continuous profits resulting into increase in reserves. Such reserves can be utilized for distribution of profits (dividend), issue of bonus shares, buyback of shares, expansion, etc. The company goes for expansion when they yield higher returns than the distribution of profits, in turn the price of share increases.

• History of issue of shares by a company can be kept into mind as to whether they have issued any bonus shares previously. It is pertinent to note that big companies like Google, Microsoft have barely announced bonus shares as they go for expansion.

• One of the parameters is product margin which means profit margin per product of the company. If the Product margin is high in turn profitability will increase, resulting in an increase in reserves and there is a possibility that the company may issue bonus shares.

Why would company issue bonus shares?

• The bonus issue tends to bring down the market price per share resulting into more reasonable range. It increases the number of outstanding shares. This promotes active trading.

• In order to make the price of the shares affordable to small investors, company may issue bonus shares.

• Share capital base of the company increases and the company may achieve more spectacular size in the eyes of the investing company.

• Shareholders after the bonus issue get a strong indication that the prospectus of the company has brightened and they can reasonably look for an increase in the total dividend. It improves the prospectus of raising additional funds in futures.

So, the bonus issue increases the participation of small investors and gives a positive sign to the market.

Write-up by: Tirth Vora