Publicly listed companies have different ways to reward their shareholders. And these rewards can either be given in the form of dividends or extra shares.
Bonus Issue and Stock Split are the two examples out of them. Where stock split and bonus issue shareholders do not have to pay anything extra.
Bonus Issue and stock split are two important corporate actions undertaken by the publicly listed companies to boost the number of shares traded. Investors usually get confused between both of these two terms.
Hence, the Funds Instructor clear the differences among these corporate actions through this blog, that will help readers to better understand the meaning of both terms.
What is a Bonus Issue?
A bonus issue, also known as a capitalization issue. In simple words, A bonus issue is when existing shareholders get extra shares in a certain proportion without paying any extra cost.
Bonus issues do not decrease shareholders’ equity, while bonus shares are issued as per the constant ratio to each existing shareholders’ stake in the company, which keeps the relative equity of each shareholder the same as before the issue.
In also addition, companies with low cash balances may issue bonus shares to shareholders rather than cash dividends as a method of providing regular income to their shareholders. Further, shareholders can sell the bonus shares to meet their liquidity needs.
Shareholders must be known that; the bonus shares may also be issued to restructure company reserves. issuing bonus shares does not involve cash flow. Where it increases the company’s share capital but not its net assets.
Issuing bonus shares increases the number of shares which leads to a decrease in the stock price of the company in proportion to the bonus ratio, which makes the stock attractive for retail investors who hesitate to invest in companies that are fundamentally strong but are available at the higher rate.
For example, if a 5:1 bonus issue is announced, shareholders will receive five shares for every one share they hold. Therefore, if an investor holds 10 shares of a certain company, the investor will get 50 (5*10) shares in total.
Note: Bonus shares themselves are not taxable. But the stockholder may have to pay capital gain tax if he/she sells them at a net gain.
Advantages and Disadvantages of a Bonus Issue
- Decrease in Share Price: Bonus issues result in a decrease in the price of the stock. If a stock is valued at ₹ 2000, then after a bonus issue, the price of the share will come down that making it easier for people with low capital to buy higher quantities of these shares.
- Capitalization of profit: Bonus share issues are essentially the capitalization of profits. Such a step always increases the company’s creditworthiness. Which helps in making the company more attractive to investors all around.
- Possibility of Dividends: As a shareholder, you get more shares with the help of bonus issues, which in turn means more possible dividend payments in the future.
- Speculation in the share market: Speculation and overall market sentiment changes leading to more volatility in the prices of the stock.
- Time-consuming process: The Issuance of Bonus shares is a lengthy process and requires a lot of regulatory approvals from various authorities.
What is a Stock Split?
When the stock prices of a company go too high, then the stock split is the step taken by that company in which the company divides its existing shares into multiple shares to boost the liquidity of shares.
with the help of a stock split a company increase, the number of shares increases but the value of the stocks remains the same. The only thing that gets divided is face value.
Under split shares, the main motive of the company is to make shares affordable to retail investors.
For example, A company announces a stock split in the 1:2 ratio. It means for every 1 share held, it will become 2 shares, for every 100 shares held, the share count will become 200 shares.
Advantages and Disadvantages of a Stock Split
- Reduction in share prices: It is the main advantage of a split is that it reduces the price of a share making it more affordable for investors.
- Increase in Trade: The number of shares traded increases, making the ownership base wider.
- Speculation in the share market: Increases speculation in the markets. This leads to higher volatility in the prices of the stock.
- Expensive Process: Stock splits are an expensive and tedious process. The legalities behind it and regulatory approvals requirements are massive.
Differences between Bonus Shares and Split Shares