Bonus Shares and Rights Shares: What They Mean for Retail Investors
As a retail investor, or someone who is just entering the world of investment, you might have come across such terms such as bonus shares and rights shares. They are typical corporate practices that firms employ either to compensate the shareholders or to raise new capital. Although these terms may be technical, the idea behind them is rather simple. When you know how they work, you are in a better position to make better investment decisions, which will not leave you confused when such announcements are made. In this article, we will explain what bonus shares and right shares are, the differences between them and what they really mean to the retail investors.
What is Bonus Share?
A bonus share refers to the extra share that a company offers to its current shareholders at no cost. These are the shares which are issued out of the accumulated profits or reserves of the company. Companies may choose to distribute profits in the form of more additional shares instead of cash dividends. In plain terms, when you are already a shareholder of a company, you can get additional shares without any cost.
Simple Example of Bonus Shares
We will get to know this by a simple example. You are a holder of 100 shares of the company and the company has been declaring a 1:1 bonus issue. This means:
- You will have 1 additional share for every 1 share you own.
- Then you will receive 100 more shares.
- The total number of shares will be 200.
But this does not indicate that your investment value doubles overnight. The bonus issue is proportional to the share price. For Example:
- If the price of the share was ₹1000 prior to the bonus issue, Following a 1:1 bonus issue, it will become approximately ₹500.
- The total value of your investment remains roughly the same initially.
What is the Reason Companies Issue Bonus Shares?
Companies normally award bonus shares due to strategic and financial reasons, such as:
1. To Reward Shareholders
It is a form of thanking the investors who had confidence in the company.
2. To Improve Liquidity
The share price is very high and thus, it cannot be afforded by many investors. The bonus shares lower the price and boost the trading.
3. To Show Financial Strength
Bonus shares issue is usually a sign of a company with good reserves.
4. To Attract New Investors
Retail participation in the lower share prices after bonus issues is sometimes more attractive.
What is Right Share?
A bonus share is not similar to a rights share. In a rights issue, a company invites its current shareholders to purchase more shares at a reduced price. Rights shares are not free unlike bonus shares. To participate, investors have to spend money. It is referred to as a rights issue because the existing shareholders have a right (first right) to purchase shares before they are sold to new investors.
Basic Example of Rights Shares
Let us see this through an example: Let us assume that you are the owner of 100 shares of a company. The firm declares a 1:4 rights issue at ₹200 per share whereas the market price is ₹260. This means:
- You are allowed to purchase 1 additional share for every 4 shares that you have.
- So you could purchase 25 more shares.
- At ₹200 instead of ₹260.
You now have three choices:
- Buy the shares
- Ignore the offer
- Sell your rights (Sell rights are tradable).
This is flexible and rights issues are not like other corporate actions.
Difference Between Bonus Shares and Rights Shares
Understanding the difference is important for every retail investor.
| Feature | Bonus Shares | Rights Shares |
| Cost | Free | Paid |
| Purpose | Reward shareholders | Raise capital |
| Source | Company reserves | Investor money |
| Investment required | No | Yes |
| Impact | More shares | Opportunity to buy more |
| Risk level | Low | Depends on company condition |
Why Do Companies Issue Rights Shares?
When companies wish to raise capital, they normally issue rights shares. Some common reasons include:
- Business Expansion: The company might require finances to undertake new projects.
- Debt Reduction: Companies sometimes raise funds to lower loans.
- Working Capital Needs: To control daily activities and costs.
- Avoiding external borrowing: Fundraising through the current investors may sometimes be cheaper than taking loans.
How Bonus Shares Impact Retail Investors?
Bonus shares might be tempting, but investors are advised to see the actual effect. Positive effects include:
- Increase in the number of shares.
- No extra investment needed.
- Improved stock liquidity.
- Positive market sentiment.
Investors are advised to keep in mind:
- Wealth does not grow overnight.
- Bonus issues affect the share price.
- The principles of the company are the same.
The advantage of bonus shares is that they are useful when the company plans to expand in the long run.
How Rights Shares Affect Retail Investors?
Rights shares are useful when they are used wisely. Advantages include:
- Buy shares at a discount.
- Retain ownership percentage.
- The chance to expand investment.
- Probable returns if the company continues to expand.
Possible risks include:
- Additional money required.
- When the fundamentals of the company are poor, it becomes risky.
- In case the market sentiment is unfavourable, the share price can also decline.
Thus, investors should always know the purpose of a company raising money.
Should You Always Buy Rights Shares?
You need to purchase rights shares under the condition that:
- The company possesses good fundamentals.
- The fundraising motive is good.
- Debt levels are manageable
- The management is of good track record.
You should be cautious if:
- The company has high debt.
- Losses are increasing.
- The issue of rights is survival and not growth.
Investing is something that should be done with the help of analysis, but never with emotions.
Important Things that Retail Investors Look Into
Retail investors should consider following important things before investing in these:
- Company Fundamentals: Profits, revenue growth and stability
- Debt Levels: The high debt can be a sign of financial stress
- Return Ratios: ROE and ROCE are indicators of efficiency
- Management Quality: Effective leadership is important in the long-term.
- Future Growth plans: Businesses should make sense in terms of expansion plans.
Common Mistakes Retail Investors Make
Many beginners make avoidable mistakes such as:
- Buying shares only because of bonus news.
- Investing blindly in rights issues.
- Ignoring company fundamentals.
- Following social media hype.
- Expecting quick profits.
Successful investors focus on business quality rather than just corporate actions.
Long-Term Investor Perspective
Bonus and rights shares must be considered in a larger context for long-term investors.
Bonus shares may indicate:
- Stable profits
- Strong reserves
- Long-term confidence
Rights shares may indicate:
- Growth plans
- Capital requirements
- Strategic expansion
But neither of these should be the sole motivation to invest. The true wealth of the stock market consists of:
- Patience
- Good companies
- Long-term holding
- Consistent learning
Conclusion
All retail investors must know about bonus shares and rights shares. Bonus shares add to the shares without added cost whereas rights shares enable the investors to purchase additional shares at a reduced price. Nonetheless, good fundamentals cannot be substituted for corporate moves. Good companies will continue to be good anyway. The most intelligent investors develop patience, knowledge and long-term investing as opposed to responding immediately to the news in the market.
Quick Links
| What is the Rights Issue? | What is Share Capital | Ex-date and Record Date |
| Types of Equity Shares | What are Bonus Shares? | Bonus Issue vs Stock Split |
Frequently Asked Questions (FAQs)
What are rights shares?
Rights shares are shares offered to existing shareholders at a discounted price, allowing them to buy additional shares in proportion to their holdings.
What is the main difference between bonus shares and rights shares?
Bonus shares are free and Rights shares require payment (usually at a discounted price).
How do bonus shares benefit investors?
Bonus shares increase the number of shares held without any additional investment, improving liquidity and potentially enhancing long-term returns.
Are rights shares worth buying for retail investors?
Rights shares can be beneficial if the company has strong fundamentals and offers shares at a significant discount to the market price.
How are bonus shares and rights shares taxed in India?
Bonus shares: Taxed when sold (capital gains apply) Rights shares: Taxed based on purchase price and sale value
How do Bonus Shares affect share price?
After a bonus issue, the share price adjusts downward in proportion to the bonus ratio, keeping the overall investment value unchanged.
What factors should investors consider before subscribing to rights shares?
Investors should evaluate:
- Company fundamentals
- Purpose of fund raising
- Discount offered
- Future growth prospects
