Skip to main content

Bonus Issues and Stock Splits - Impact on investors

Issuing bonus shares is different from a stock split. Let us first understand what happens in each of these cases.

 

In a bonus issue, the company gives free shares to its existing shareholders on a pro-rata basis. For instance, if a company declares a bonus of 2:1, the investor gets two additional shares for each share that he already owns. Thus a company does not raise additional capital through a bonus issue. It merely converts some of the free reserves (profits accumulated over the years that have not been distributed as dividend) into share capital and issues additional shares to investors. The net impact is that the company's reserves decline while its share capital increases. And that's exactly the purpose behind issuing bonus shares - converting some of the excess reserves into share capital.

A stock split results in the conversion of a high-priced stock into a low-priced stock. For instance, if the stock currently has a face value of Rs10, its face value could be reduced to Rs 2 and five shares could be issued to the investor in lieu of every Rs 10 share held by him. In this case, the face value of shares is reduced in a certain proportion and the number of shares is increased in the same proportion. Again, the total share capital of the company remains unchanged. After both these measures - a stock split and a bonus issue - the net worth of the company remains unaffected.

 

Let us now go on to your next question regarding why companies go in for a bonus issue or a stock split, and how they decide which of these two options to go for.

 

Generally, companies that are fundamentally strong and feel that their stock has become highly priced go for a stock split. The basic idea is to make the shares more affordable for retail investors, who otherwise might give its shares a miss at high price levels. Usually stock splits increase the liquidity of the stock in the market. After the split, the stock becomes more affordable and hence more investors are able to buy it. Due to increased demand, the stock's price moves northward, which is the basic underlying motive for the stock split.

 

The biggest benefit of issuing bonus shares is that it sends out a positive signal that the company is in a position to service its larger equity base. Management does not increase the number of shares unless it is confident of being able to increase its profits and distribute dividends on all these shares in future. Hence, an issue of bonus shares is treated as a sign of the company's good health by the market.

 

Impact on investors

Investors see a bonus issue as a mark of management's confidence in the company's prospects. Most investors view a bonus issue as a reward to them. Similarly, a stock split too is welcomed by investors. However, in reality both a stock split and a bonus issue are a zero-sum game for shareholders. Let's see what this means.

 

After a bonus issue, though the number of shares held by an investor increases, his proportional ownership of the company's shares does not change. As the number of outstanding shares of the company increases, its earnings per share (EPS) declines. Theoretically then the share price should also fall by the same factor as the decline in EPS. Hence the increase in number of shares is offset by the decline in stock price. In a nutshell, a bonus issue doesn't impact investors' wealth. However, more often than not, the consequent demand push for shares causes the price to move up. So investors do get some benefits after all.

 

Stock splits too bring no real advantages to investors. However, post the split of a fundamentally strong company, more investors get attracted to the stock which is less expensive now. This increases the demand for the stock, thereby leading to an increase in its price, which may then stabilise at a higher level.

 

Popular posts from this blog

All about "Derivatives"

What are derivatives? Derivatives are financial instruments, which as the name suggests, derive their value from another asset — called the underlying. What are the typical underlying assets? Any asset, whose price is dynamic, probably has a derivative contract today. The most popular ones being stocks, indices, precious metals, commodities, agro products, currencies, etc. Why were they invented? In an increasingly dynamic world, prices of virtually all assets keep changing, thereby exposing participants to price risks. Hence, derivatives were invented to negate these price fluctuations. For example, a wheat farmer expects to sell his crop at the current price of Rs 10/kg and make profits of Rs 2/kg. But, by the time his crop is ready, the price of wheat may have gone down to Rs 5/kg, making him sell his crop at a loss of Rs 3/kg. In order to avoid this, he may enter into a forward contract, agreeing to sell wheat at Rs 10/ kg, right at the outset. So, even if the price of wheat falls ...

Zero Coupon Bonds or discount bond or deep discount bond

A ZERO-COUPON bond (also called a discount bond or deep discount bond ) is a bond bought at a price lower than its face value with the face value repaid at the time of maturity.   There is no coupon or interim payments, hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its par (or redemption) value. In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures. Zero-coupon bonds may be long or short-term investments.   Long term zero coupon maturity dates typically start at 10 years. The bonds can be held until maturity or sold on secondary bond markets.

Mutual Fund MIPs can give better returns than Post Office MIS

Post Office MIS vs  Mutual Fund MIPs   Post office Monthly Income Scheme has for long been a favourite with investors who want regular monthly income from their investments. They offer risk free 8.5% returns and are especially preferred by conservative investors, like retirees who need regular monthly income from their investments. However, top performing mutual fund monthly income plans (MIPs) have beaten Post Office Monthly Income Scheme (MIS), in terms of annualized returns over the last 5 years, by investing a small part of the corpus in equities which can give higher returns than fixed income investments. The value proposition of the mutual fund aggressive MIPs is that, the interest from debt investment is supplemented by an additional boost to equity returns. Please see the chart below for five year annualized returns from Post office MIS and top performing mutual fund MIPs, monthly d...

Benefits Of Repo Rate & CRR Rate Cut On Consumers

  How Reduction In Repo Rate & CRR Affects Customers Finally  RBI announced slashing of repo rate by 25 basis points (bps ) and cash reserve ratio (CRR) by 25 bps which industry experts believe will fuel the economic growth to some extent. Although experts were expecting higher rate cut this year. This lowering of the rate cuts has taken place for the first time in nine months. Now let's see how reducing the repo rate (defined in economic term as the rate at which RBI lends money to the banks) relates to the following individuals and sectors: Banking:   Lowering of repo rate directly reduces borrowing costs of a bank. Banks in turn reduces interest rates on different types of loans such as home, auto, business etc. Similarly trimming down of CRR allows banks to unlock money for lending to the customers i.e. with 0.25 rate cut banks are estimated to lend more than INR. 17 Crores. Consumers:   Lower repo rate does not necessarily benefit existing loan borrowers but new loan se...

NRI Corner: The process of remittances abroad

The process of remittances abroad, and back, is cumbersome. Here’s how you can wade through without hassles Approach The Right Place Outward remittances or the process of sending money abroad is governed by many regulations. In India, outward remittances are made mainly through banks. At the outset, you need to remember that you just cannot trust any individual or a financial firm with the responsibility of sending your money. Experts recommend that you should always try to choose a bank with an international footprint, which will make your job easier. Choose Mode Of Transfer The next step is to choose the mode of transfer. One option is to get a Foreign Currency Demand Draft ( FCDD ). This draft will be denominated in foreign currency and should be drawn in favour of the recipient/ beneficiary. The beneficiary does not necessarily need to have an account with the same bank. The other option is to send money via wire transfer. Do not be puzzled if the bank official uses the word SWIFT ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now