In the Indian stock market, seasoned investors often encounter corporate announcements about bonus shares and share splits. Understanding these financial maneuvers can prove beneficial for investors aiming to optimise their portfolio. This article delves into everything investors need to know about bonus shares, elaborating on their significance, mechanics, and the comparison with a share split.
What Are Bonus Shares?
Bonus shares are free shares given to existing shareholders by a company, usually in lieu of dividends. These shares are distributed from a company’s retained earnings or reserves, implying that no fresh capital is raised. The primary purpose behind issuing bonus shares is to enhance the liquidity of stocks and reward shareholders without a cash outflow.
Why Do Companies Issue Bonus Shares?
Companies might issue bonus shares for several reasons:
- Liquidity Enhancement:
By increasing the number of shares, companies aim to boost the market liquidity, making their shares more actively traded. - Shareholder Rewards:
When companies opt for bonus issues, it signals positive sentiment and rewards their loyal investors without immediate cash disbursement. - Attractive Price:
After the bonus issue, share prices decrease due to increased share count, potentially attracting new investors who find lower prices more accessible.
How Do Bonus Shares Work?
To explain how bonus shares work, consider a hypothetical scenario involving Company X, trading at INR 1000 per share. Let’s assume Company X declares a 2:1 bonus issue, meaning shareholders receive two additional shares for each share they hold.
Suppose an investor holds 100 shares before the bonus issue:
- Pre-bonus: 100 shares at INR 1000 per share = INR 100,000 investment value
- Post-bonus: The investor receives 200 bonus shares, totalling 300 shares
If the market adjusts the stock price to approximately INR 333 after the bonus, the calculation would be:
- Post-bonus total value = 300 shares × INR 333 = INR 99,900
Although the number of shares has increased, the total investment value remains nearly the same, indicating no immediate monetary gain but improved liquidity.
Bonus Shares Vs. Share Split
While both bonus shares and share splits result in more shares in the hands of shareholders, they involve distinct financial mechanisms.
Bonus Shares
These are free allocations to existing shareholders, derived from a company’s reserves, reflecting a reward without any financial input from shareholders.
Share Split
A share split involves dividing the existing equity shares into multiple shares without altering the overall equity capital. For example, in a 1:2 share split, each existing share is split into two. The shareholder’s total investment value remains unchanged but is reflected through a larger number of shares at a lower price per share.
Understanding the difference between bonus shares and what is share split is crucial for investors to interpret such announcements accurately and align their portfolio expectations.
Impact on Investors
Price Adjustments
Bonus shares and share splits lead to a natural adjustment in the stock price due to the increase in the number of shares. While the overall value remains the same, the per-share price declines. Investors must watch for mismatches between intrinsic value and market price post such corporate actions.
Liquidity and Market Dynamics
Both actions increase the liquidity of the stock. Improved liquidity can attract a broader investor base, making shares more appealing and potentially more stable in price.
Converted Value and Wealth Perception
While bonus shares and splits may create an illusion of increased wealth, they simply redistribute the same total value. Investors should consider these events as indicators of company confidence rather than wealth creators.
Taxation on Bonus Shares
When bonus shares are allotted, they come at zero cost. However, tax implications arise upon selling them.
- Cost of Acquisition: As per Indian tax laws, the cost of acquisition for bonus shares is considered zero.
- Capital Gains Tax: If sold, the entire proceeds are treated as capital gains. This can lead to a tax liability depending on the holding period and the investor’s tax slab.
Therefore, planning tax-efficient exits becomes vital to maximise post-tax returns on bonus shares.
Bonus Shares Issuance Trend
Many companies in the Indian stock market favour issuing bonus shares to highlight their strong financial health and commitment to shareholders. Monitoring bonus issuance trends can provide valuable insights into corporate performance and investor sentiment.
Conclusion
Understanding the mechanisms of bonus shares enables investors to make more informed portfolio decisions. Although the immediate investment value remains unchanged, these actions reflect corporate strength and intent to reward shareholders.
Long-term investors should factor in such announcements as part of a strategic investment approach. Moreover, recognising the distinction between bonus shares and what is share split helps decode company policies and market signals more effectively.
By mastering these concepts, investors can better interpret company announcements, align their expectations, and fine-tune their market strategies for optimal results.
- Everything About Bonus Shares Issued by Companies for Investors
- Bonus shares are free shares given to existing shareholders by a company, usually in lieu of dividends.
- Bonus Shares, Share Split
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