What are Bonus Shares?

Bonus shares are additional shares allotted to shareholders, increasing their total shares. Companies issue them to reward investors, boost EPS, and strengthen capital
OPEN ACCOUNT
What are Bonus Shares?
OPEN ACCOUNT
3 mins read
28-October-2024

Bonus shares are additional shares granted to existing shareholders at no extra cost, based on the quantity of shares they currently hold. These shares represent the company's retained earnings, which are allocated as free shares instead of being issued as dividends.

What are bonus shares?

Bonus shares are additional shares issued by a company to its existing shareholders at no extra cost. These bonus shares are issued to shareholders based on the number of shares they currently own.

If you are wondering when bonus shares are issued by companies, there is no fixed rule regarding the timing of bonus issues. Companies generally announce bonus share offerings if they have surplus profits but cannot or do not wish to distribute them in the form of dividends. As far as how bonus shares are issued, the issue typically requires approval from the company’s Board of Directors, following which the shares are credited to shareholders’ accounts.

Types of bonus shares

Bonus shares can be classified into two main types: fully paid bonus shares and partially paid bonus shares.

1. Fully paid bonus share

Fully paid bonus shares are those shares for which the shareholder has already paid the entire amount due at the time of issuance. When a company distributes fully paid bonus shares, it does not require any further payment from its shareholders. These bonus shares are allotted to the existing shareholders in proportion to their existing holdings, without any additional financial burden on their part.

2. Partially paid bonus share

Partially paid bonus shares, on the other hand, are shares for which the shareholder has paid only a portion of the total amount due. In this scenario, the company issues bonus shares to its shareholders, but they are still required to make further payments to fully own these shares. The additional payment needed to fully pay for these bonus shares is usually communicated by the company along with the issuance.

Both types of bonus shares aim to enhance shareholder value and confidence by increasing the number of shares held by investors without diluting their ownership stake in the company. However, it's essential for investors to understand the terms and conditions associated with bonus share issues, particularly in the case of partially paid bonus shares, to avoid any misunderstandings or financial implications.

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Reasons for issuing bonus shares

Issuing bonus shares is a strategy that companies employ for multiple financial and strategic reasons. Here are the primary reasons why companies decide to issue bonus shares:

1. Capitalisation of reserves

Bonus shares allow companies to convert accumulated earnings from reserve accounts into share capital, distributed among existing shareholders relative to their current holdings.

2. Increase in share liquidity

Issuing bonus shares enhances market liquidity by increasing the number of shares available, making it easier for smaller investors to trade.

3. Affirmation of confidence

This move can signal the management's belief in the company's long-term profitability and robust health.

4. Adjustment of share price

The issuance of bonus shares typically lowers the share price, making the stock more accessible to a wider range of investors without affecting the overall market capitalisation.

5. Earnings Per Share (EPS) adjustment

While EPS may initially decrease, the reduced share price can attract more investors, potentially increasing future earnings.

6. Encouragement of retail participation

A lower share price post-issuance can encourage more retail investors to buy shares, diversifying the investor base and stabilising the stock price.

7. Psychological impact

Issuing bonus shares can create a positive perception of the stock and reinforce shareholder loyalty.

Overall, issuing bonus shares utilises internal resources efficiently, optimises stock market performance, and strengthens shareholder relations while promoting broader investor support.

Bonus shares calculation

Bonus shares are issued to shareholders in a specified ratio. For example, say a company issues bonus shares in a 3:1 ratio. This means you will receive 3 shares for every 1 share in your portfolio. So, if you hold 100 shares in the company, you will receive 300 bonus shares.

What is the record date?

The record date is the cut-off date set by a company to determine which shareholders are eligible for its bonus issue. It is essential because the demand for a company’s shares may rise when a bonus issue is announced. As shares continue to change hands daily, even after the announcement of the bonus issue, new shareholders replace old ones.

This makes it difficult to identify which shareholders are eligible for the bonus shares. Identifying a specific record date as the cut-off makes it easier for companies to determine shareholders’ eligibility when bonus shares are issued.

Additional read - What are preference shares

Eligibility for allotment of bonus shares

Shareholders who own company shares on the record date are eligible to receive the bonus shares. In this context, there are two important dates that you should be aware of — the record date and the ex-date.

The record date is when the company checks its records to identify eligible shareholders for its bonus issue. The ex-date is the date by which you should purchase the company’s shares if you want to be a registered shareholder by the record date. Since the settlement cycle in India follows a T+1 schedule, the ex-date is generally one or two trading days before the record date.

Let us look at an example to understand how eligibility for a bonus issue of shares works.

Suppose a company announces a bonus issue on April 5th and sets the record date as April 26th. This means the ex-date is April 25th. So, you must purchase shares in the company by April 25th if you want the advantage of its bonus shares. This way, you will appear as a registered shareholder in the company’s records in T+1 days, i.e. by April 26th, which is the record date.

Why do companies issue bonus shares?

Companies may issue bonus shares for various reasons. They include:

  • Lowering the current price per share.
  • Promoting liquidity for its shares in the secondary market.
  • Improving retail investor participation.
  • An alternative to dividend payments to shareholders.
  • Boosting the company’s reputation in the market.

Advantages of bonus shares

Bonus shares are beneficial to shareholders in many ways. The advantages of bonus shares include the following:

  • Bonus shares give investors more shares, increasing their investment and making it easier to buy and sell stocks.
  • Those who get bonus shares don't have to worry about paying taxes because there aren't any.
  • They are great for people who want to invest for a long time because it helps them make more money over a wider range.
  • When companies pay out dividends, people who have bonus shares get more money because they own more shares..
  • Having bonus shares makes investors trust the company more because it can grow without spending extra money.

Disadvantages of bonus shares

While issuing bonus shares offers benefits, it also presents some disadvantages from both the investor's and the company’s perspectives:

From an investor's point of view

  1. Dilution of Earnings Per Share (EPS): Receipt of bonus shares increases the number of shares held but doesn't change the total profits, resulting in a reduced EPS. This lower EPS can negatively affect the valuation perceived by potential investors.

From a company’s point of view

  1. No cash inflow: Issuing bonus shares does not generate cash as they are funded from the company's reserves. This method redistributes retained earnings into share capital without adding new funds, limiting the company's capacity to invest in new projects or reduce debt.
  2. Reduced flexibility for future capital raises: With more shares in circulation, future capital raising efforts may require issuing more shares to raise equivalent funds, potentially diluting the stock further and possibly lowering the price.
  3. Potential misinterpretation of financial health: Regularly issuing bonus shares rather than dividends might suggest to the market that the company lacks sufficient cash for dividend payouts, which could lead to concerns about its liquidity and cash flow.
  4. Increasing costs over time: The administrative and regulatory costs associated with issuing bonus shares can accumulate and managing a complex share structure can be administratively burdensome.

Conditions for the issue of bonus shares

For a successful bonus issue, the following conditions need to be met by the company:

  • The company’s Articles of Association (AoA) must authorise a bonus issue.
  • If the AoA does not sanction the issue of bonus shares, a special resolution must be passed at the company’s general meeting.
  • The company’s Board of Directors must approve of the issue.
  • The shareholders must also sanction the issue.
  • The total share capital of the company, including the bonus issue, must be less than or equal to its authorised capital.

How bonus share is different from stock split?

Bonus shares and stock splits are both corporate actions that increase the number of shares outstanding, but they differ in their mechanics and implications for shareholders.

Aspect

Bonus shares

Stock splits

Nature of issuance

Issued free of charge to existing shareholders.

Existing shares divided into multiple shares.

Purpose

Improve liquidity, reward shareholders.

Reduce share price, increase affordability.

Accounting treatment

Capitalised from retained earnings or reserves.

No impact on financial accounts.

Impact on share price

Does not directly affect share price.

Adjusts proportionately, lowering price per share.


Conclusion

You can keep up with the news to track all upcoming bonus issues and purchase shares of promising companies before the ex-date. This will help you diversify your portfolio and multiply your investments in a cost-effective manner.

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Frequently asked questions

What is bonus shares in simple terms?

In simple terms, bonus shares are extra shares that a company gives to its existing shareholders. Companies issue bonus shares to use their saved reserves, enhance EPS, and boost their paid-up capital. Shareholders get these shares at no extra cost, also known as free shares.

Does the issue of bonus shares enhance the company’s value?

Yes, the issuance of bonus shares can enhance a company's value. When a company issues bonus shares, it effectively capitalizes a part of its retained earnings or reserves, converting them into share capital. This action increases the company's total equity, which can improve its financial health and balance sheet.

Can I sell bonus shares?

Yes, you can sell bonus shares, but only once they have been credited to your demat account. Shares from a bonus issue are typically credited about 15 days after the ex-date. If you attempt to sell the shares before they are credited, you could face an auction due to the lack of available shares in your account to fulfil the sale order. It's crucial to check that the shares are actually in your demat account before you attempt to trade them.

Does share price fall after a bonus issue?

Yes, the share price usually falls after a bonus issue, but the total market value of your holdings remains the same. This price adjustment results from an increase in the number of shares outstanding. For example, if a company announces a 3:1 bonus issue, and the share price before the bonus is Rs. 200, after the bonus the price would adjust to approximately Rs. 50 per share. This is because the total number of shares increases, in this case, from 100 to 400, spreading the value of the company over more shares while keeping the same overall market capitalisation.

What are bonus shares?

Bonus shares are free shares given to existing shareholders by a company. They are issued based on the number of shares you already hold (e.g., 2 bonus shares for every 1 share held). Imagine you own 100 shares of a company with a 1:1 bonus issue. You will receive 100 additional shares for free, increasing your total holdings to 200.

Is it good to buy bonus shares?

Bonus shares themselves do not directly impact your investment value. The company's total worth stays the same, spread across more shares. The share price usually adjusts proportionally after the bonus issuance. So, if you were considering buying shares, it might be a good time to wait until the post-bonus price settles.

What does a 1:2 bonus share mean?

A 1:2 bonus share means you will receive 1 bonus share for every 2 shares you currently hold. For example, with 100 shares and a 1:2 bonus, you'd get 50 bonus shares (100/2 = 50), bringing your total to 150 shares.

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