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Do Bonus Shares really enhance your wealth?

March 1, 2010

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
% Gain/Loss
@Ex Bonus Price
% Gain/Loss
@current Price
Intra Infotech 02:01 28/01/2010 17.2 18.05 16.9 4.94% -1.74%
Nakoda Textiles 01:01 22/01/2010 14.36 16.3 12.07 13.51% -15.95%
Websol Energy 01:01 29/12/2009 172.05 171.9 136.5 -0.09% -20.66%
Splash Media 03:01 23/12/2009 135.71 142.45 194 4.97% 42.95%
JP Associates 01:02 17/12/2009 144.93 149.4 125.25 3.08% -13.58%
CNI Research 01:01 17/12/2009 16.78 16.9 17.3 0.72% 3.10%
Diamond Cables 01:03 16/12/2009 122.59 128.75 115.6 5.02% -5.70%
Int Conveyor 01:01 10/12/2009 40.12 42.1 34.2 4.94% -14.76%
Adani Enterpris 01:01 10/12/2009 422.43 429 467.2 1.56% 10.60%
Valson Ind 01:01 07/12/2009 35.63 39.15 24 9.88% -32.64%
Reliance Industries 01:01 26/11/2009 1096.88 1064.6 981.3 -2.94% -10.54%
IOCL 01:01 29-10-2009 321.2 315.25 307.9 -1.85% -4.14%
Numeric Power 01:01 14/10/2009 254.3 259.3 315.35 1.97% 24.01%
Anil Modi Oil 01:01 14/10/2009 22.23 21.1 13.85 -5.08% -37.70%
Sundaram-Clayton 01:01 09/10/2009 116.25 114.6 115.3 -1.42% -0.82%
Falcon Tyres 02:01 25/09/2009 155.66 156.4 179.75 0.48% 15.48%
Jaybharat Textiles 01:02 16/09/2009 344.3 361.5 452.35 5.00% 31.38%
Jindal Steel 05:01 14/09/2009 562.05 575.5 609.85 2.39% 8.50%
Ramcoind 01:01 14/09/2009 62.99 66.05 55.35 4.86% -12.13%
Hiran Orgochem 04:01 10/09/2009 10.46 10.95 8.5 4.68% -18.74%
Navneet 03:02 08/09/2009 39.02 42.6 45.4 9.17% 16.35%
Country Condos 02:01 04/09/2009 7.48 7.8 5.18 4.28% -30.75%
Tilaknagar Ind 02:01 02/09/2009 72.78 76.35 100 4.91% 37.40%
GEE 01:04 25/08/2009 57.88 60.7 50.2 4.87% -13.27%
Linkson Interna 02:01 21/08/2009 22.67 23.75 87.15 4.76% 284.43%
Glodyne Techno 01:01 20/08/2009 361.65 379.7 485.35 4.99% 34.20%
Kanani Industr 02:01 20/08/2009 158.5 163.58 249 3.21% 57.10%
Orient Abrasive 01:01 12/08/2009 21.4 21.6 27.65 0.93% 29.21%
Vishal Info 01:02 06/08/2009 18.97 20.8 11.5 9.65% -39.38%
Munoth Capital 07:02 05/08/2009 14.9 15.63 17 4.90% 14.09%
Avance Tech 04:01 03/08/2009 1.39 1.47 4.47 5.76% 221.58%
TRF 01:01 31/07/2009 422.1 409.8 752.4 -2.91% 78.25%
Divis Labs 01:01 30/07/2009 552.98 551 567.85 -0.36% 2.69%
Veer Energy 01:02 29/07/2009 18.97 19.84 8.73 4.59% -53.98%
Ind Tra Deco 02:03 27/07/2009 0.46 0.48 0.38 4.35% -17.39%
Anus Labs 01:01 24/07/2009 13.03 15.6 7.22 19.72% -44.59%
Transcorp Int 01:02 02/07/2009 31.63 33.15 43.8 4.81% 38.48%
Dolphin Offshore 02:05 29/06/2009 196.86 206.65 370 4.97% 87.95%
Indiaco Venture 01:01 19/06/2009 41.7 43.75 53.05 4.92% 27.22%
TCS 01:01 16/06/2009 389.3 389.8 726.05 0.13% 86.50%
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4 Comments leave one →
  1. Shyam permalink
    March 20, 2010 4:52 pm

    nice..

  2. manoj gautam permalink
    May 9, 2010 7:03 pm

    it is nice i have to make my assignment on this topic it helps me a lot

    thanks

  3. Karthik Veera permalink
    August 7, 2010 12:48 pm

    I am 20 years old and I need some help and insight. In 2009 I Incorporated a Pvt. Ltd.company with 2000 authorized shares @ Rs. 1/share. Then I invested around Rs. 50000 to setup my business. Since, I needed more funds I asked my friend to loan me some interest free money. He lend me around Rs. 200000. Now after a year he wants to buy stake in my company against the loan he gave me. But his father who is settled abroad (Gulf) has asked me some information and hence, I have following questions:

    1. What is the authorized start up capital of my company? also explain how you arrived at that figure.

    2. Can I increase the no. of issued shares in my company? How and with what impact?

    3. I initially invested Rs. 500000 so does that mean the value of the share at that point was Rs. 250 as in Rs.500000/2000 (no. of shares Issued)?

    4. At what rate per share I should I sell stakes in my company? We are breaking even no profit but good future orders for our software?

    I want to be majority shareholder with atleast 65% if not more. Please, help me

    • September 5, 2010 11:57 am

      Hi Karthik
      Sorry for the late reply. Havent been very active lately.Tthough you have given limited information, I will try to answer your questions.
      1. Let me explain the meaning of authorized capital first. Authorized capital is that capital which is decided by the
      Registrar (recruited under companies act,1956) as the maximum amount that can be raised from the shareholders.
      So in your case, when your company got incorporated, appointed registrar must have prescribed a limit till you can raise capital from public (or by issuing shares). For eg. if your registrar has authorized your company to raise share capital till Rs 2000, them you have used 100% limit to raise capital by issuing share (to yourself in this case). Since you have said that you have issued 2000 authorized shares of Rs 1 each, this will be your authorized start up capital.

      2. here i am bit confused by your question. I am assuming that you want to increase number of shares and not equity capital. Number of shares can be increased in two ways, either by issuing fresh shares (raising capital) or by splitting your existing shares. Since you have already exhausted your authorized capital limit (again I assume!), you cant increase number of shares by issuing fresh shares. Hence, only option you have is to split your existing shares. In this case face value (Rs 1) of your shares will get reduce in proportion of splits. Also, earnings per share will be reduce in the same proportion but equity capital will remain same (Rs. 2000).

      3. Well we cant actually say this Rs 250 is the value of per share of your company. Its actually the invested amount per share of your company which does not represent the value of the company. And as the old saying goes ‘You’re not really worth anything until you’re profitable’, you must generate cash flow and profit to correctly value your company. 🙂

      4. This decision is agin lies with you. After carefully analyzing the current as well future prospect (Cashflow etc) of your company, you can arrive at a fair value per share.
      Hopefully i have answered most of your queries. Do reply in case you need further assistance.

      All the best.

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