What are Bonus Shares ?

In the evolving landscape of the Indian stock market, the term bonus shares often catch the attention of investors. But what does it exactly mean, and why is it significant?

Simply put, bonus shares are additional shares a company gives to its existing shareholders without any extra cost. These shares are issued from the company’s accumulated earnings and are a way to reward shareholders.

Bonus Share – Definition

The bonus shares, also known as a “stock dividend” or “scrip issue,” are additional shares that a company gives to its existing shareholders at no extra cost. These shares are issued from the company’s accumulated earnings and are a way to reward shareholders.

Bonus shares are usually distributed in proportion to the number of shares a shareholder already owns. For elxample, suppose a company announces a 1:1 bonus. In that case, it means that shareholders will receive one additional share for every share they already own, effectively doubling their shareholding without any financial outlay.

The concept of this is straightforward yet holds immense significance in the Indian capital market.

Why Do Companies Issue Bonus Shares?

Companies issue bonus shares for a variety of reasons:

1. Capitalisation of Profits

   Instead of distributing profits as dividends, companies may convert these profits into share capital. This helps in capitalising the company’s earnings without affecting its cash flow.

2. Market Perception

   Bonus shares can positively impact market perception. While the company’s intrinsic value remains the same, the reduced share price post-bonus issue often attracts new investors.

3. Increased Liquidity

   Issuing bonus shares increases the number of shares in circulation, thereby improving the stock’s liquidity. This makes the stock more attractive to potential investors.

How Are Bonus Shares Different from Stock Splits?

It’s crucial to distinguish bonus shares from stock splits. In a stock split, the face value of the share is divided, increasing the number of shares but keeping the total share capital constant.

In contrast, bonus shares increase the total share capital by converting reserves into share capital without affecting the face value of individual shares.

Impact on Shareholders

From a shareholder’s perspective, bonus shares are beneficial for multiple reasons:

1. No Tax Liability:

   Unlike taxable dividends, bonus shares have no immediate tax implications for the shareholder.

2. Capital Appreciation:

   Over the long term, as the company continues to grow, the value of the original and bonus shares may appreciate, offering higher returns.

3. Increased Ownership:

   The issuance of bonus shares increases a shareholder’s stake in the company without requiring additional investment.

Guidelines to be Followed by a Company Before Issuing Bonus Shares

• Board Approval

  The first step is getting approval from the company’s board of directors.

• Shareholder Approval

  Subsequently, the shareholders must approve the issuance of bonus shares through a special resolution.

• Regulatory Compliance

  Companies must adhere to SEBI and the Companies Act of 2013 guidelines.

• Sufficient Reserves

  Companies should have enough free reserves to cover the bonus share issuance without impacting their operational capabilities.

• No Default

  The company should not default in payment of interest or principal on fixed deposits or debt securities issued by it.

• Credit Rating

  If the company has obtained any credit rating for its debt instruments, it must not be a default rating.

• Statutory Auditors

  The issuance process should be audited to ensure compliance with legal requirements.

• Information Disclosure

  Complete disclosure of the bonus issuance should be made to stock exchanges to maintain market transparency.

• Record Date Announcement

  A clear announcement specifying the ‘record date’ for the bonus issue is mandatory.

Advantages and Disadvantages Of Bonus Shares

Advantages

1. Increased Liquidity:

   The issuance of bonus shares increases the number of shares in circulation, thus enhancing liquidity.

2. Market Appeal:

   The share price typically decreases post-bonus issuance, making it more affordable for new investors.

3. Shareholder Goodwill:

   Bonus shares improve relations with existing shareholders as they feel rewarded.

4. No Tax Impact:

   For shareholders, bonus shares are generally not taxable until sold, unlike dividends, which are taxable when received.

5. Capital Structure:

   For companies, issuing bonus shares helps optimise the capital structure without affecting cash reserves.

Disadvantages

1. Earnings Dilution:

   With more shares in circulation, the Earnings Per Share (EPS) may decline, potentially impacting the share price.

2. No Real Gain:

   While it appears that the shareholder is getting ‘extra’ shares, the overall value of the investment remains the same as the share price adjusts accordingly.

3. Operational Pressure:

   Companies may face pressure to maintain higher earnings to meet shareholder expectations regarding the bonus issue.

4. Complexity:

   The bonus issuance process involves various regulatory approvals and compliances, making it complex and time-consuming.

5. Expectation Burden:

   Once a company sets a precedent of issuing bonus shares, shareholders may expect this to happen regularly, which may not always be feasible.

It’s about more than just the immediate gain in the number of shares. Several other factors should be considered to comprehend the full impact of a bonus share issuance.

How Bonus Shares Will Be Credited?

Crediting bonus shares to the shareholders’ accounts is a structured procedure involving multiple steps. Here’s how it generally works:

1. Announcement

   The first step involves the company publicly announcing the issuance of bonus shares, including crucial details like the ratio and the record date.

2. Record Date

   This is the date on which the company checks its records to identify the shareholders eligible for receiving the bonus shares. Only those holding the shares as of this date will qualify.

3. Ex-date

   This is the date after which the shares start trading ex-bonus. Anyone buying the shares after this date won’t be eligible for the bonus shares.

4. Crediting Demat Account

   For shareholders who hold shares in dematerialised form, the bonus shares are directly credited to their Demat accounts .

5. Physical Shares

   In the rare case where shares are held in physical form, new share certificates are issued to the shareholders.

6. Time Frame

   The time taken for the bonus shares to be credited can vary but is generally done within a week of the record date.

7. Confirmation

   Shareholders often receive an email or SMS notification confirming the credit of bonus shares to their Demat accounts.

8. Ledger Update

   The shareholder ledger of the company is also updated to reflect the new shareholding pattern post the bonus issue.

9. Tax Implications

   It’s important to note that these shares will have a different cost base for tax purposes, usually set to zero, affecting the capital gains calculations when these shares are sold.

Understanding the method and timeframe of how bonus shares will be credited can help investors manage their portfolios more effectively.

What Happens to the Share Price When Bonus Shares Are Issued?

The issuance of bonus shares directly impacts a company’s share price, and understanding this is crucial for investors in the Indian stock market. Here’s what generally happens:

1. Immediate Reaction

   The announcement of bonus shares usually leads to increased tradingvolumes, and often, the share price sees a short-term surge due to the positive sentiment.

2. Price Adjustment

   The share price adjusts to account for the additional shares issued on the ex-date. For example, if the bonus ratio is 1:1, the share price will approximately halve.

3. Market Capitalisation

   The company’s overall market capitalisation remains the same immediately after the bonus shares are issued. The price per share decreases, but the number of shares increases proportionately.

4. Liquidity Impact

   The increase in shares improves liquidity, making the stock more accessible to small investors, which can result in higher trading volumes.

5. Psychological Factor

   The reduced share price post-bonus can make the stock appear more ‘affordable,’ attracting new investors even though the company’s intrinsic value remains unchanged.

6. Long-term Impact

   Over the longer term, the impact on the share price depends on the company’s performance. If the company continues to perform well, the share price and overall market capitalisation may increase, benefitting both original and new shareholders.

7. Earnings Per Share (EPS)

   Since the number of shares has increased, the EPS will reduce proportionately, which some investors may view negatively. However, this is a mathematical outcome of the bonus issue and not necessarily a reflection of the company’s health.

8. Investor Perception

   Finally, how investors perceive the issuance of bonus shares can also influence the share price. If the issuance is seen as a sign of the company’s confidence in its future prospects, it can positively impact the share price in the long term.

Is Dividend Paid on Bonus Shares? Are Bonus Shares Good for Investors?

One of the common queries among Indian investors is whether dividends are paid on bonus shares and if acquiring bonus shares is a good investment strategy.

The answer to the first question is yes. Dividends are usually paid on bonus shares. Once bonus shares are issued, they carry all the rights of ordinary shares, including eligibility for dividends, unless specified otherwise by the company.

This means that post the bonus issue, not only does the investor have more shares, but they also potentially earn more in dividend income, adding an extra layer of benefit.

Now, are bonus shares good for investors?

The answer generally leans toward yes for several reasons:

1. No Immediate Tax Liability

   Bonus shares are not subject to immediate taxation, unlike dividends, which are taxed when received.

2. Increased Ownership

   Bonus shares offer a way to increase one’s ownership without additional investment, which is especially beneficial in a growing company.

3. Psychological Benefit

   The issuance of bonus shares often creates a positive sentiment in the market, sometimes boosting the stock’s price in the short term.

4. Enhanced Liquidity

   More shares in the market mean better liquidity, making it easier to buy or sell shares.

However, it’s important to remember that while the number of shares you own increases, the total value of your investment remains the same immediately after the bonus issue. So, the issuance should not be the sole factor in evaluating the investment’s attractiveness.

When Should I Buy Bonus Shares?

Timing is everything in the stock market, and the same applies to acquiring bonus shares in the Indian context. So, when is the ideal time to buy?

1. Pre-Announcement Phase

   If you strongly believe a company will issue bonus shares, buying before the announcement can be profitable. The stock price often surges after the announcement.

2. Post-Announcement but Pre-Record Date

   Once a company announces the issuance of bonus shares, there’s usually a rise in stock price due to the positive sentiment. Buying before the record date ensures you are eligible for the bonus shares.

3. On or After Ex-Date

   You won’t be eligible for the bonus shares if you buy the shares on or after the ex-date. However, you might benefit from the usually lower share price. If the company is fundamentally strong, this could be an entry point for long-term investment.

4. Post Bonus Issue

   After the bonus shares are issued and the market adjusts, it may be a good time to assess the company’s fundamentals and consider buying if the stock is undervalued.

5. Dividend Considerations

   If the company has a history of paying substantial dividends, owning more shares post the bonus issue can result in higher dividend income.

6. Tax Planning

   From a tax perspective, buying shares at least one year before selling can be beneficial as long-term capital gains tax is generally lower than short-term.

Always align your investment timing with your overall financial goals and risk tolerance.

What is the Eligibility for Getting Bonus Shares?

When it comes to receiving bonus shares, understanding eligibility criteria is crucial for investors in the Indian financial market. The eligibility for bonus shares generally revolves around a few key parameters:

1. Existing Shareholders

   The primary rule is straightforward: You must be an existing shareholder of the company that is issuing bonus shares. New investors who buy the stock after the ex-date won’t be eligible.

2. Record Date

   The company will announce a specific “record date” along with the bonus issue. You need to be a registered shareholder of the company on this date to qualify for the bonus shares.

3. Type of Shareholders

   Both individual retail investors and institutional investors like mutual funds can be eligible to receive bonus shares. However, preference shareholders are usually not eligible unless explicitly stated by the company.

4. Shareholding Proportion

   Bonus shares are issued in a specific ratio to the number of shares already held. For example, suppose a 1:1 bonus issue is declared. In that case, it means that for every share you hold, you will receive one more share at no extra cost.

5. Demat Account

   The bonus shares are credited directly to your Demat account for most modern transactions, so having an active account is essential.

6. Locked-in Shares

   If any of your shares are locked in due to regulatory requirements or as part of some contractual agreement, those shares generally won’t be counted as bonus shares.

7. Pending Litigations

   Any legal issues or disputes surrounding your shareholding could interfere with your eligibility to receive bonus shares.

8. Dividend Reinvestment Plan (DRIP) Shares

   If you are part of a Dividend Reinvestment Plan, whether those reinvested shares are eligible for bonus shares will depend on the company’s specific policy.

9. Employee Stock Options (ESOPs)

   Shares acquired through ESOPs are generally eligible for bonus shares. However, confirming this through official company announcements or communication is advisable.

10. Foreign Investors

    Foreign Institutional Investors (FIIs) and Non-Resident Indians (NRIs) who are shareholders are also generally eligible for bonus shares, subject to regulatory approvals and guidelines.

Knowing the nuances of eligibility can significantly affect how you plan your investment strategy around the issuance of bonus shares. It helps you ensure that you do not miss out on the benefits of bonus shares, such as increased shareholding, potential for more dividends, and long-term capital appreciation. Being well-informed about these criteria is crucial for optimising your investment returns in the Indian stock market.