For many investors, receiving free shares in a company they have invested in is quite an attractive value proposition. It is one of the reasons why stock bonuses appear to be an exciting option among investors in the stock market.
However, you must understand the intricacies of bonus shares before you add them to your investment portfolio. In this guide, we will discuss everything about bonus shares, including what is a bonus share, its purpose, types, impact on the market, and more.
What is Bonus Shares?
Bonus shares are extra shares issued by a company to its existing shareholders, free of cost. As a shareholder, you can sell these stocks in the secondary market to fulfil your liquidity requirement. In addition, the companies can issue bonus shares even when they do not require cash and cash equivalents.
What is the Purpose of Bonus Shares?
After understanding the meaning of bonus shares, you must learn about their purpose. There are certain occasions when a company cannot pay dividends in cash, owing to possible cashflow storage, though the company has gained good turnover. In such situations, the company may offer bonus shares to the existing shareholders instead of dividend payments.
Bonus shares are issued from fresh or additional shares, free of cost and proportionate to the shareholder’s stake. Anytime the company issues bonus shares, there is a profit ‘capitalisation’, which involves the transfer of profits of a firm or its reserves to share capital.
A company is never compensated by its shareholders for issuing bonus shares. An amount equivalent to the bonus issue’s value is debited from the reserve or profits and credited to the Equity Share Capital Account.
What are the Benefits of Bonus Shares?
Bonus shares offer several benefits to the shareholders and investors. Here is a list of advantages of bonus shares:
Advantages for the Company
The following are certain benefits a company can reap by issuing bonus shares:
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Increases Share Capital
When a company issues bonus shares, it increases its share capital without incurring extra cash flow. It helps the company to effectively increase its share capital by issuing additional shares to its current shareholders. Hence, it is a cost-effective way for the company to expand its capital.
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Improves Market Liquidity
If a company issues bonus shares, it increases the total number of shares available for trading in the market. Therefore, it will increase the share liquidity in the market. It can be seen that higher liquidity makes a stock more attractive and accessible to investors, as they can easily buy and sell it.
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Enhances Market Capitalisation
The declaration of bonus shares by a firm does not result in any change in its existing market capitalisation. However, the distribution of bonus shares can potentially lead to an increase in the market capitalisation of the firm through better scope for investors to trade. If the trading volume increases, so will investors’ interest.
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Improves Shareholder Trust and Brand Image
When a company distributes bonus shares to its existing shareholders, it can enhance the shareholders’ trust and the company’s brand image. It initiates trust among the shareholders that the company is financially successful and willing to share its profit among investors. Hence, it improves shareholders’ loyalty and promotes a positive relationship between both parties.
Advantages for the Shareholders
The following points highlight the advantages of bonus shares for investors:
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No Cash Outflow
Investors prefer bonus shares as they get additional shares without paying anything extra. It implies that they can increase their holding in the company without putting in additional capital. This is useful for investors who need to enhance their investments without stretching their finances too thin.
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Enhanced Portfolio Size
Usually, a bonus issue increases the number of shares held by an investor, leading to a larger portfolio size. It can enhance the overall value of their holding, particularly if the company performs well after the issue. A larger portfolio can also lead to increased diversification and risk management.
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Tax Efficiency
Bonus shares may be more tax-efficient than cash dividends. Investors do not need to pay immediate taxes on bonus shares because taxes are typically deferred until the shares are sold. It can lead to increased tax planning opportunities and reduced overall tax costs for investors in the long run. However, they must pay the capital gains from sales.
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Price Adjustment
Share prices typically fall proportionally following a bonus share issuance to reflect the increased number of shares available in the market. However, this adjustment does not alter the overall value of the investment. Investors like the sense of continuity because their overall investment value remains intact despite the share price adjustment.
What are the Different Types of Bonus Shares?
The following are the different types of bonus shares:
Fully Paid Bonus Shares
Fully paid bonus shares are distributed to investors at no additional cost based on their existing holdings. These shares are issued from various sources, including profit and loss accounts, capital reserves, capital redemption reserves, or security premium accounts. This distribution enhances shareholder value without requiring further investment.
Partly Paid Bonus Shares
Partly paid bonus shares differ from fully paid shares as they are not fully paid up to the total issue price. Investors can acquire these shares without paying the full amount upfront. The outstanding balance can be settled in instalments when the company issues a call for payment.
What is the Impact of Bonus Shares on Shareholders and Market?
After understanding what are bonus shares, you must have a look at their impact on shareholders and the market. Here is how bonus shares impact the shareholders and the market:
Impact on Shareholder Value
Although shareholders warmly welcome bonus issues, they can still significantly affect their investment value. For instance, every shareholder will own more shares but also experience an increased dilution of ownership because each owner’s proportionate stake is diminished with every extra issue.
Furthermore, bonus issues impact a company’s earnings per share (EPS). With more shares released into circulation, the same amount of earnings is spread over a larger base, potentially reducing EPS. Therefore, this may affect investor perception and negatively influence the portfolio of an investor.
Impact on the Market
The announcement of bonus issues typically elicits strong reactions in the stock market. Initially, investors may respond positively, viewing the bonus issue as an indicator of the company’s financial stability and promising future. However, the subsequent effects on stock prices can be more nuanced.
The increase in total number of shares resulting from a bonus issue alters the supply and demand dynamics. With a greater number of shares available, supply rises. If demand remains unchanged, this surplus can exert downward pressure on stock prices. Conversely, if the bonus issue is well-received and enhances investor confidence, demand for the company’s shares may increase, potentially mitigating the dilution effect.
What is the Process of Issuing Bonus Shares?
Here is the process of issuing bonus shares to existing shareholders of a company:
Step 1: Call a Board Meeting
Convene a meeting of the board of directors to discuss the following:
- Increase in authorised capital, if necessary
- Issuance of bonus shares
- Necessary actions to organise a General Meeting to pass an Ordinary or Special Resolution, if required by the articles
Step 2: Issue Notices for the General Meeting
Prepare and send out notices for the General Meeting, including an Explanatory Statement.
Step 3: Conduct General Meeting
Hold the General Meeting and ensure that a resolution for bonus share issuance is passed.
Step 4: File Required Forms with ROC
Submit the necessary forms to the Registrar of Companies (ROC).
Step 5: Hold Allotment Meeting
Conduct a Board Meeting or Committee Meeting, as authorised, to allocate bonus shares to eligible shareholders.
Step 6: File Allotment Forms
Complete and submit the required forms to allot bonus shares.
Step 7: Issue Share Certificates
Distribute share certificates to shareholders and update relevant registers accordingly.
Step 8: Report to RBI
If there are any Non-Resident (NR) or Non-Resident Indian (NRI) shareholders, report to the Reserve Bank of India (RBI) as required.
Final Words
Bonus shares help companies reward shareholders without immediate cash outflow. While they can enhance shareholder value by increasing the number of shares held, they may also dilute ownership and impact earnings per share. Ultimately, the effectiveness of bonus issues hinges on market perception and investor confidence in the company’s future.
Go through the above sections to understand what is a bonus share, its types, and related information before adding them to your investment portfolio.
