A lot of companies issue bonus shares in India. Bonus shares become of an immense importance when considered from a long-term investment point of view. This is because along with the company’s share price over such a long tenure, the number of shares held by an investor also gets multiplied. So let us discuss in detail what is a bonus issue, some terms related to it, its advantages and disadvantages, and finally its types.
Bonus shares refer to the additional number of shares that a company gives its shareholders in a pre-announced proportion to their existing holding. A 2:1 bonus issue means that investors will receive two additional equity shares for each share held by them. Given other factors remain constant; the share price will be reduced to one-third of the pre-bonus issue price so that the total market capitalization of the company remains the same. Otherwise, every company would be able to increase its market value simply by issuing more number of shares.
Companies may issue bonus shares when it is not in a position to pay cash dividends but also wants to reward its shareholders. Issuing bonus shares to existing shareholders is also known as capitalization of profits as they are given out of the reserves of the company.
Following are some terms related to bonus shares:
Since trading of shares takes place on a daily basis, there has to be some date or cut/off in order to decide who are the shareholders that are eligible to receive the bonus shares to be issued by the company. Record date is that date where the shareholder’s name should be present in the company’s record, so that the company can decide to whom all should the bonus shares be credited.
Ex-date is the date one day before the record date. Simply put, an investor has to buy shares at least a day before the ex-date to become eligible for the bonus shares.
Shareholders who have the company’s shares in their demat account before ex-date and the record date are eligible to receive bonus shares from the company. If the shareholders purchase the company’s shares on the ex-date, they will not be eligible to receive bonus shares. Bonus shares are then credited to the shareholder’s account within a 15-day time period.
Following are the advantages of bonus shares:
- Bonus shares prove to be beneficial of investors who have a long-term tenure of holding their shares because their investment multiplies over this long time-period.
- The company’s investors do not need to pay any money when bonus shares are issued. They are free of cost and enhance liquidity in the company’s stock.
- Bonus share issuance helps in building investors’ trust in the company as the latter is rewarding shareholders.
- There is no tax liability on investors when they receive bonus shares.
- Bonus share issuance increases the company’s value and brand image in the market.
- Bonus share issuance can be seen as an alternative to dividend payments by the company when it does not prefer to pay cash to its shareholders and that too without upsetting them.
- After the bonus issue, the number of company’s free-floating shares in the market increases.
Following are the disadvantages of issuing bonus shares:
Many investors perceive that a bonus issue will increase the value of their investments in the company, but the number of shares held by an investor doubles, while the share price adjusts itself accordingly, keeping the total investment value unchanged.
The company does not receive any cash by issuing bonus shares, and the ability to raise money later is minimized.
There are two different types of bonus shares. They are:
Fully paid up bonus shares are those shares that are distributed at zero cost to investors in the proportion of their existing shareholding. These types of bonus shares can be issued from the profit and loss account, capital reserves, capital redemption reserves, or the security premium account.
A partly paid share is the one that is only partially paid as compared to the full issue price. When bonus shares are issued in partly paid shares and converted into fully paid shares without calling out the uncalled amount, the mechanism is known as partly paid bonus shares. Partly paid bonus shares cannot be issued through a capital redemption reserve account or a security account.
So this was all an investor should know about bonus issues to participate when companies come up with them. But investors should always look at other company fundamental prospects before jumping to invest in its shares.
Also Check: What is Stock Splits?