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 post will explore the difference between bonus issue and stock split, including their definitions, reasons for occurrence, and potential impact on shareholders.

Topics Covered:

• What is a Bonus Issue?
• Pros and Cons of a Bonus Issue
• What is a Stock Split?
• Pros and Cons of a Stock Split
• Bonus Issue vs Stock Split
• In Summary

What is a Bonus Issue?

A bonus issue is a corporate action where a company distributes additional shares to its existing shareholders at no extra cost.

The number of bonus shares allocated to each shareholder is usually determined based on the shares they already own. This distribution of additional shares allows the company to reward its shareholders and increase the total number of outstanding shares.

Pros and Cons of a Bonus Issue

Advantages of a bonus issue:

1. Enhanced Shareholder Loyalty: Issuing bonus shares can strengthen ties with existing shareholders, fostering loyalty and improving their confidence in the company.

2. Improved Stock Liquidity: Increased shares in circulation facilitate easier buying and selling, enhancing stock liquidity and market activity.

Disadvantages of a bonus issue:

1. Earnings Dilution: The distribution of additional shares may dilute earnings per share, impacting the company's financial performance as earnings are divided among a larger number of shares.

2. Lack of Cash Inflow: Unlike other capital-raising methods like rights issues or IPOs , a bonus issue doesn't bring in any cash to the company. It redistributes existing shares among shareholders without adding new capital to the firm.

What is a Stock Split?

A stock split is a corporate action that involves dividing the company's existing stock into multiple shares to lower the trading price of individual shares. Essentially, it is a way for companies to increase the number of shares outstanding while maintaining the same market capitalisation.

The company determines a split ratio during a stock split, such as 2-for-1 or 3-for-1. This means that for every existing share held by a shareholder, they will receive two or three additional shares, respectively. The purpose of this division is to reduce the price per share, making it more affordable for investors to buy.

Additionally Read: What is Demat Account?

For example, if a stock trades at Rs 100 per share and undergoes a 2-for-1 split, shareholders would receive an additional share for each share they own, and the price per share would be halved to Rs 50. This allows for greater market participation and can attract a wider range of investors.

The mechanics of a stock split are typically executed by a company's board of directors and require approval from shareholders. Once the split is announced, the total number of shares outstanding increases, but the overall value of the company remains the same. Shareholders' ownership percentage in the company also remains unchanged.

So, a stock split involves dividing a company's existing stock into multiple shares to lower the trading price of individual shares. 

Pros and Cons of a Stock Split

Advantages of a Stock Split:

1. Improved Liquidity: Stock splits increase the number of shares available in the market, leading to increased trading volume and liquidity. This can attract more investors and potentially enhance price stability.

2. Affordability: By lowering the price per share, stock splits make the company's stock more affordable for individual investors. This can encourage broader participation and increase demand for the stock.

3. Perception of Growth: Investors often perceive stock splits as a positive signal, suggesting that the company is experiencing growth and increasing its shareholder base. This can attract attention and potentially drive up the stock price.

Disadvantages of a Stock Split:

1. Perceived Value Reduction: While a stock split does not affect the overall market capitalisation or the value of an investor's holdings, some investors may perceive a lower share price as a sign of decreased value or financial performance. This perception can temporarily impact the stock's price and investor sentiment.

2. Administrative Costs: Implementing a stock split involves administrative tasks such as updating shareholder records, issuing new shares, and notifying regulatory bodies. These activities can incur costs and require additional resources from the company.

3. Potential Speculation: In some cases, stock splits can attract speculative traders focusing solely on short-term price movements. This increased trading activity can introduce volatility and distort the stock's true value.

Stock splits offer benefits such as improved liquidity and affordability while presenting drawbacks like perceived value reduction and administrative costs. Companies and investors should carefully consider these factors before implementing or participating in a stock split to make informed decisions regarding their investment strategies and trading accounts

Bonus Issue vs Stock Split

Regarding corporate actions that impact a company's shares, the concept of bonus issue vs stock split is commonly employed. While they both involve increasing the number of outstanding shares, they differ in terms of purpose, impact on share capital, effect on shareholder value, and market perception. To gain a clear understanding of the difference between bonus issue and stock split, let's compare them side by side in the table below: 

Note that both bonus issues and stock splits do not directly impact shareholder value. While the number of shares held by individual shareholders may change, the overall market capitalisation and the value of their holdings remain the same.

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In Summary

Both bonus issues and stock splits are tools companies use to increase their share capital and make their stocks more affordable to investors. While bonus issues involve issuing free additional shares to existing shareholders, stock splits divide existing shares into smaller units. Both methods can positively affect a company's stock price and market liquidity. 

Understanding the difference between bonus issue and stock split is essential for any investor looking to make informed choices in the stock market.