Bonus shares are additional shares issued by a company to its existing shareholders free of cost, essentially distributing accumulated profits or reserves in the form of shares rather than cash dividends. This mechanism increases the number of shares an investor holds without requiring any further investment, while simultaneously boosting the company's liquidity and making its shares more accessible to a wider range of investors.
Understanding Bonus Shares
A bonus issue occurs when a company converts a portion of its reserves and surplus into share capital. Instead of paying out cash dividends, which would reduce the company's cash reserves, it opts to issue new shares to its current shareholders. These shares are allocated in proportion to the existing shares held by each investor.
Why Companies Issue Bonus Shares:
- Conserving Cash: It allows companies to reward shareholders without depleting their cash reserves, which can then be used for business expansion or other operational needs.
- Increasing Liquidity: A larger number of shares in circulation typically improves the trading liquidity of the stock in the market.
- Lowering Per-Share Price: While the total market capitalization remains the same immediately after the issue, the per-share price decreases, making the shares more affordable and attractive to new investors.
- Signaling Financial Health: Issuing bonus shares can be perceived as a positive signal, indicating that the company has strong reserves and is confident about its future profitability.
The Mechanism of Bonus Share Distribution
When a company declares a bonus issue, it announces a specific ratio, such as 1:2, 1:1, or 2:1. This ratio dictates how many bonus shares an investor will receive for their existing holdings.
- Ex-Bonus Date: Similar to dividends, there's an "ex-bonus" date. To be eligible for bonus shares, an investor must hold the shares before this date.
- Record Date: This is the date on which the company identifies the eligible shareholders based on their holdings.
- Allotment: Eligible shareholders automatically receive the bonus shares credited to their demat accounts within a specified period.
Practical Example: 1:2 Bonus Issue
Let's illustrate how bonus shares work with a concrete example based on a common bonus ratio:
Suppose a company declares a 1:2 bonus share issue. This means that for every two existing shares an investor holds, they will receive one additional bonus share for free.
Here's how it would affect a shareholder:
| Scenario Detail | Before Bonus Issue | After 1:2 Bonus Issue |
|---|---|---|
| Existing Shares Held | 2,000 shares | 2,000 shares |
| Bonus Shares Received | 0 | 1,000 shares (calculated as 2,000 * 1/2) |
| Total Shares Held | 2,000 shares | 3,000 shares |
| Original Share Price (e.g.) | ₹150 per share | Adjusts proportionally (e.g., to ₹100) |
| Total Value of Investment | ₹300,000 (2000 * 150) | ₹300,000 (3000 * 100) |
Explanation:
In this example, if a shareholder holds 2,000 shares of the company, when the company issues bonus shares at a 1:2 ratio, they will receive 1,000 bonus shares (2,000 existing shares multiplied by the 1/2 ratio). This increases their total shareholding from 2,000 to 3,000 shares.
While the number of shares increases, the total value of the investor's holdings theoretically remains the same immediately after the bonus issue, as the share price typically adjusts downwards proportionally. For instance, if the share was trading at ₹150 before the bonus, after a 1:2 bonus, the price would likely adjust to around ₹100 per share (₹150 original price / 1.5 increase in shares = ₹100 new price per share).
Impact on Shareholders and Market
- No Direct Cost: Shareholders receive these additional shares without having to pay anything.
- Increased Shareholding: The primary benefit for investors is the increase in the total number of shares they own.
- Potential for Future Gains: While the immediate value per share drops, the increased number of shares means that any future price appreciation or dividend payments (if declared per share) would apply to a larger base, potentially leading to higher overall returns in the long run.
- Improved Affordability: The reduced per-share price after a bonus issue can make the stock more attractive to smaller investors, potentially increasing its investor base.
Bonus shares are a strategic corporate action that benefits both the company by conserving cash and improving market dynamics, and the shareholders by increasing their equity stake in the company without any additional financial outlay.
