Do Bonus Shares really enhance your wealth?
We all enjoy getting bonuses at work. Don’t we? Bonus is something you get free and that’s why we all love it! That is what shareholders of a good company feel when their company decides to throw a few shares (free of cost) in their direction. Investors like to invest in companies which give bonus shares. A bonus issue is taken as a sign of the good health of the company. Let us see, what bonus shares are all about and why investors like investing in such companies.
What are bonus shares?
Bonus shares, as the name suggests, are issued free to existing stockholders in proportion to the number of stocks held by them. It is essentially a book transfer by which a sum of money equal to the value of the bonus shares is transferred from the reserves to the equity capital in the company’s books of accounts. The issue of bonus stocks enlarges a stockholder’s stockholding without any dilution in his proportionate ownership of the company. These shares are issued in a particular proportion to the existing holding. For example, 1 for 1(written as 1:1) bonus would mean you get one additional shares, without paying anything at all, for the one share you hold in the company. Similarly if the company has declared 2:1 bonus share that means you will get two shares for one share you have. Thus a shareholder holding two shares, post bonus holds three shares of the company. Or, if you hold 100 shares of a company and a 2:1 bonus offer is declared, you get 200 shares free. After the bonus issue, total number of shares of that company will now be 300 instead of 100 at no extra cost. The company also announces a record date for the issue of bonus shares. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus. After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.
Is it actually free?
Though, bonus shares don’t cost to shareholders technically, bonus shares are not free. Companies do not generally distribute their entire profits to the stockholders as dividends. A fairly large part of the profit is retained and added on to what is commonly called the reserves of the company. Reserves are back up funds which a company keeps for meeting unforeseen increases in expenditure, and for financing its future expansion or diversification programmes. But when the reserves have more cash than required for the reinvestment, then companies use these free cash reserves for issuing bonus shares to share holders. For this, the company transfers some amount from the reserves account to the share capital account by a mere book entry. Bonus shares are issued by cashing in on the free cash reserves of the company. As, shareholders do not pay; the company’s profits are also not affected by issuing these bonus shares. Bonus shares increase the total number of shares of the company in the market, i.e. after the bonus issue a company will have more free floating shares in the market.
Let’s see how. Suppose initially, a company had 10 million shares. This year the company decides to issue bonus shares in 2:1 proportion. With a bonus issue of 2:1, there will be 20 million shares issues in addition to 10 million existing shares in the market. So now, there will be total 30 million shares. This is also referred to as equity dilution. The earnings of the company will also have to be divided by the increased number of shares. Since, bonus issue has no impact on the profit, it remains the same but the number of shares has increased, the EPS will decline.
Will the price change after a bonus issue?
Ideally, the stock price should also decrease proportionately to the number of new shares issued. But, in reality, proportionate price changes may not occur. That happens mainly because of increased liquidity and enhanced investor confidence in the company’s management. After the bonus issue, the stock becomes more liquid which makes it is easier to buy and sell. Also, issuing bonus shares signals that the company is in a position to service its larger equity. A company will not normally issue bonus stocks unless it is confident that its future growth prospects justify an expansion in its equity capital. Therefore, the expectation of a bonus issue by any company normally creates a climate of optimism and cheer in the stock markets and usually results in a rise in the price of a company’s stocks just before or upon the announcement by it of a bonus issue.
Does bonus issue increase your gains?
Though, getting bonus shares is a positive development for the investors, bonuses may not necessarily generate free gains for investors. Bonus issue does create a tiny upward and short-lived bias because of above mentioned reasons. But for most of the companies this appreciation in price dies in the long run. If we look in Indian stock market, we see that except for some large companies like TCS, bonus issues did not add much to investor wealth, especially in the long run. In fact, investors in several companies have lost substantially, even after taking into account extra shares they received through bonus issues. Anu’s Lab is a notable example of this phenomenon. Anu’s Lab gained more than 19% the day it became ex-bonus but its price started slumping soon after. Currently Anu’s Lab is trading at 44% lower price compared to its pre-bonus price (see the list).
Below table gives a list of 40 companies which issued bonus shares in FY 2009-10. As expected, most of the companies (32 out of 40) reported appreciation in stock prices soon after they became ex-bonus. But this euphoria could not stay very long for most of the companies. Out of these 40 companies, only 21 companies could maintain their price appreciation (as on 5th Feb 2010). Out of these 21 companies, only 16 companies are reporting more than 15% price appreciation. Companies like Anu’s lab, Vishal InfoTech, Country Condo, Veer energy and Anil Modi Oil are trading way below their pre-bonus prices. Investors, who invested in these companies with the motive of handsome appreciation in future, must have burnt their fingers badly. Investment in such companies has resulted into depletion of wealth instead of appreciation of investor’s wealth. So we can say that buying a share solely because of the bonus issue is a “purely speculative” trade. It has very little to do with enhancing investors wealth. Though companies with bonus issues attract a lot of interest in the current market which creates an up move in stock prices, the long run sustainability of the up-trend mainly depends on other factors like fundamentals of the company and general market conditions. Before making any investment decision, investors need to do through fundamental analysis of bonus-issuing companies.
List of Companies with Bonus Issues in FY2009-10
*Prices are adjusted after bonus and splits. †Prices on 5 Feb 2010.
|Company||Bonus Ratio||Ex-BonusDate||Pre Bonus Price*(Adjusted)||Ex-Bonus Price*(Adjusted)||Price† on 5Th Feb 2010
@Ex Bonus Price
|Anil Modi Oil||01:01||14/10/2009||22.23||21.1||13.85||-5.08%||-37.70%|
|Ind Tra Deco||02:03||27/07/2009||0.46||0.48||0.38||4.35%||-17.39%|