Saturday, 20 July 2013

Issue of Bonus Shares by Companies

Issue of bonus shares by a company, like declaring dividends, is another way in which the company rewards its shareholders. Time and again we have heard in the news about some company or the other issuing bonus shares to its shareholders. In this post we will discuss more about bonus shares, how and why they are issued and what’s in it for investors.

Bonus Shares :

Bonus shares are fully paid up shares issued to existing shareholders as per a ratio agreed by the company’s board and/or shareholder approval. It is also known as scrip issue or capitalisation issue.

How Are Bonus Shares Issued :

The undistributed part of accumulated profit of the company over a period of time, which is part of the reserve account, is used to as equity capital to issue the bonus shares. The shareholders need not pay anything extra to get the bonus shares.

Reasons For Issuing Bonus Shares :

  • Company share capital increases.
  • Marketable security increases.
  • May arrest the share price fall in dull economic scenario.
  • Increasing the liquidity in the market.
  • Bonus shares prove to be more rewarding overtime than dividends. This is for the following reasons :

    • When dividend is declared, the company incurs a dividend distribution tax, which is a liability. Issuing bonus shares does not attract any such taxation.
    • Though there is a adjustment (reduction) in the CMP of the shares when bonus shares are issued, over a period of time, as the company grows and share value appreciates, it is obvious that the shareholder is amply rewarded for investing in the company for a long period of time. For this reason, good blue chip company are always good for investors.
There are some other points about issue of bonus shares that are worth noting :

  • The EPS, book value and CMP get reduced in proportion to the enlarged outstanding equity shares.
  • Market cap remains unchanged.
  • Shareholding pattern doesn’t change.
  • Accumulated profit decreases but Networth remains same. Let’s explain with an example.
    • - Say, X= No. of paid up shares=10000
      - Y= Face value of shares=10
      - Equity Capital = X*Y = 100000
      - Z= Reserve & Surplus=900000
      - Now, (X*Y)+Z = 100000 + 900000 = 1000000 = Networth.
      If the company declares bonus in the ratio of 1:1 then a total of 10000 additional fully paid up shares are issued for which the funds from reserve & surplus account are used.
      - So, now X = 20000
      - Equity Capital = X*Y = 20000*10 = 200000
      - New reserve & surplus Z = 900000 - 100000 = 800000
      - But Networth still remains at (X*Y)+Z = 1000000
  • Issue of bonus shares may show some increase in the company’s ROE.
  • That a company has decided to issue bonus shares should mean that the company has shown strength in generating profits and is expecting to do so in future.
  • There is no new fund generation for the company due to the issue of bonus shares.
All in all, the issue of bonus shares should be seen as a positive for the shareholder and the company. Conversely, companies which have issued such bonus shares regularly in the past are good investment options for shareholders.