Difference Between Bonus Issue and Stock Split

Bonus issues and stock splits - while both of these events involve a change in the number of shares an investor holds, key differences between them can have significant implications. This article will explore the difference between bonus issue and stock split, including their definitions, reasons for occurrence, and potential impact on shareholders.

Investing in stocks is relatively easy. You research stocks through technical and fundamental analysis and invest in them if you feel that they are undervalued and can rise in price in the future. Once you invest, you become the shareholder of the company and part owner, entitled to a share in the company’s profits through dividends. However, when you invest in listed shares, the company that has offered its shares has the right to change the number of shares you hold through two processes called bonus issues and stock splits. These two processes can benefit your overall return as they increase the number of shares you hold.

If you are an investor or looking to invest, it is important to understand bonus issues and stock splits, as they are common in the Indian stock market. This blog will help you understand the difference between a bonus issue and a stock split for a better investment approach and handling of your investments.

Key Takeaways

• A bonus issue is when a company gives additional shares to existing shareholders for free, based on their current number of shares.
• A stock split is when a company issues more shares to shareholders by splitting the current shares, reducing the share price proportionally.
• As they directly affect the number of shares held by shareholders, it is vital to understand the difference between a bonus issue and a stock split.

The first factor in understanding the difference between a bonus issue and a stock split is learning about a bonus issue. A bonus issue, also known as a scrip issue, is a stock market process where a company that has its shares listed on the stock exchanges issues additional shares to its current shareholders at no additional cost. During a bonus issue, the shareholders get an additional number of shares as a bonus based on the number of shares they already hold.

Bonus shares are issued in proportion to the existing shares. For example, a 1:1 bonus issue means that for every share a shareholder owns, they receive one additional share. Although bonus shares increase the number of shares, a shareholder's investment value remains the same, as the stock price usually adjusts by falling to reflect the increased number of shares outstanding.

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Here are the pros and cons of a bonus issue:

Pros:

• Reward: Bonus issues reward the current shareholders by increasing the number of shares they hold. They can earn more per share through capital appreciation and dividends.
• Higher liquidity: A bonus issue increases the outstanding number of shares, making the stock more liquid and easier for investors to buy and sell.
• No cash outflow: The company does not need to spend cash to reward shareholders, preserving its cash reserves for other uses.

Cons:

• Dilution of Earnings Per Share (EPS): As a bonus issue increases the number of shares outstanding, it dilutes the EPS, negatively affecting the stock valuation.
• Share price drop: The share prices drop in proportion to the bonus issue as the outstanding shares increase. This can lead to a sell-off, further decreasing the share price.
• No cash inflows: Unlike other money-raising issues, such as IPOs or FPOs, a bonus issue does not generate revenue for the company and may force it to incur administrative costs.

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The next step in understanding the difference between a bonus issue and a stock split is knowing what a stock split is. A stock split is a corporate action taken by a listed company where it issues additional shares to its current shareholders by splitting the existing stocks in a specific ratio. A stock split increases the total number of shares in the hands of the shareholders and the company's overall outstanding shares. Stock splits are typically announced in ratios, such as 2-for-1, 3-for-1, or 5-for-2. For example, in a 3-for-1 split, shareholders receive three shares for every share they previously owned.

Since a stock split increases the outstanding number of shares, the share price decreases after a stock split. This happens because the stock adjusts to reflect the increased number of shares. For instance, if a stock is priced at Rs. 100 before a 2-for-1 split, it would be priced at Rs. 50 after the split. After a stock split, the total value of the investment remains unchanged. If you owned 100 shares at Rs. 100 each before the split, you would own 200 shares at Rs. 50 each after the split.

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Here are the pros and cons of a stock split:

Pros:

• Increased liquidity: A stock split can increase market liquidity by increasing the total number of outstanding shares, making buying and selling shares easier.
• Affordability: As share prices fall after a stock split, the stock becomes more accessible to a wider range of investors, including smaller retail investors who can not afford a high-priced stock.
• Market perception: Investors may see a stock split as a positive sign, indicating that the company is performing well and that its stock has risen to a good price level.

Cons:

• Dilution of perceived value: Although the actual value of the investment doesn’t change, investors might perceive the split as diluting the value of their shares, as they now hold more shares at a lower price.
• Administrative costs: Stock splits involve administrative work, such as seeking permission from SEBI, updating records, and issuing new shares, which can cost the company money.
• Share price fall: Stock splits generally result in a share price fall as the shares adjust to the additionally issued shares. If investor sentiments turn negative, this can lead to a sell-off.

Here is a detailed table showcasing the difference between bonus issues and a stock split:

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As an investor, it is vital to understand the difference between a bonus and a stock split, as these two corporate actions are common in the Indian stock market. Bonus issues are used to reward shareholders by increasing the number of shares they hold. In contrast, a stock split is generally issued to increase the liquidity of the shares by making them affordable. Now, you can better manage your investments and portfolio when there is a bonus issue or a stock split.