A bonus share is an additional share bestowed by a company to its existing shareholders free of cost. When the company, despite a profitable turnover, is unable to pay cash dividends to its shareholders due to a possible dearth of liquidity, the company issues new or additional shares in the form of bonus shares to its shareholders. Bonus shares are issued in proportion to the shares and dividends held by a shareholder, and no additional charges are levied on the shareholders by a company for issuing bonus share stocks.
Despite having ample liquidity, companies may still issue bonus shares to avoid the high dividend distribution tax levied on them. This tax must be paid by the companies at the time of dividend declaration.
Information on Bonus Shares
The additional shares which are given to existing shareholders of a company with no charges involved are called bonus shares. These are not to be confused with a rights issue. These also include shares that may be issued to existing shareholders of a company. However, while bonus shares are issued “free”, as a stock bonus, the shares from a rights issue are not. They may be offered to shareholders at a lower rate (a discount), but the additional shares must be purchased by existing shareholders at a price.
A rights issue may also be generated for different reasons than bonus shares given out. A rights issue offers several shares, which are paid for if the shareholder wishes to buy them. Therefore, there is capital to be made by the company on selling these. A company may, therefore, offer a rights issue to raise capital for any reason, from company expansion to the requirement for the acquisition of another corporation. Bonus shares, on the other hand, are given free to shareholders when companies cannot generate dividends as there is a shortfall of liquidity in the company.
A Bonus Issue of Shares
- The term bonus issue of shares or bonus share issue indicates an issue of bonus shares by a company to its shareholders.
- Companies issue bonus shares based on a constant ratio formula that permits the distribution of a fixed number of shares to the shareholder depending on the number of shares they already hold.
- For instance, a bonus shares example would be, say, a shareholder owns 100 shares of company X. Now the company has decided to issue bonus shares in the ratio of 2:1, meaning the shareholder gets two bonus shares for each share they own. As a result, the shareholder shall now have 200 bonus shares for the 100 shares owned.
- Upon a bonus issue of shares, the dividend per share decreases as there is an increase in the number of shares.
- The share value decreases upon a bonus issue, keeping intact the investment value of the shareholder as the number of shares owned by a shareholder is higher than before.
Advantages of Bonus Shares
- A key benefit of bonus shares is that they assure its shareholders about the company’s calibre to service larger equity and also promote goodwill amongst shareholders. It is crucial, however, for shareholders to know the bonus shares calculation, so that when these may be issued, the correct amounts due are received by shareholders.
- A decrease in the share value with the bonus issue of shares serves as an attractive option for investors.
- When the company makes huge profits, its stock prices go up. As a result, the bonus shares fetch handsome profits to its shareholders when transacted in the secondary markets for liquidity.
Some Considerations
The bonus issue is based on the amount of shares that an existing shareholder currently holds. There are no cash payments made by shareholders for bonus shares, so the position that determines liquidity does not change. However, something that is crucial to be aware of is that the per-share dividend falls as the number of shares increases due to the issue of bonus share stocks. In a direct way, this does not impact the company issuing the bonus issue in terms of value or capital. Unlike a rights issue, the shareholder’s company investment does not face any dilution. The investment's value does not get altered simply because, although a decrease is experienced in the per-share income, the holder of shares now owns more number of shares. The essential purpose of the issuance of bonus stock is to equalise the excess in assets with “nominal share capital”.
Stock Bonus Eligibility Criteria
The eligibility for bonus shares depends on the record date and ex-date of the shareholders.
The record date is a cut-off date set by the company, and the investors must be shareholders of the company before this date for them to be eligible to receive stock bonus share issues. Besides, the ex-date is a day preceding the record date set by the company.
In India, the delivery of shares into a Demat account takes place two days after the trading date. All existing shareholders before the ex-date and record date are eligible to receive bonus shares issued by a company. However, to qualify for bonus shares, the company stocks must be bought before the ex-date.
Any stocks bought on the ex-date shall not be eligible for an issue of bonus shares as the ownership of the stocks cannot be gained by the investor before the record date.
Conclusion
A bonus stock issue acts as an assurance by the company. This assurance means that the said company issuing bonus stock can service any of the larger equity it holds. What this essentially translates to, in simple words, is that any company would not issue bonus shares unless it were sure that it would turn profits from dividends and shares in the future. Consequently, bonus issues promote a sense of goodwill from the company. Companies that issue bonus shares do so by following the constant ratio formula, which permits for a set number of stock for every shareholder according to the amount of shares outstanding.
Once a new ISIN (International Securities Identification Number) is allocated to the bonus shares, they are credited into the shareholder’s Demat account within 10-15 days. Shareholders shall receive an SMS or Email about the credit of bonus shares into their Demat account, or shareholders can directly log in to their online Demat accounts to check their statement that reflects the delivery of bonus shares on a given day. You should be aware that a company can only be permitted to issue bonus stock if the Articles of Association sanction this action. In case the Articles of Association cannot do this, a special resolution must be passed at the general meeting of the company concerned.
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As an expert in finance and investment, I have a comprehensive understanding of various financial instruments, including stocks, dividends, and corporate actions like bonus shares. I have practical experience in analyzing company performances, understanding shareholder rights, and comprehending the intricate workings of the stock market.
Bonus shares, also known as stock bonuses, are an additional allocation of shares distributed by a company to its existing shareholders without any cost. This issuance occurs when a company, despite having a profitable turnover, might face liquidity constraints and consequently cannot pay cash dividends to its shareholders. Instead of cash dividends, the company issues bonus shares to existing shareholders, proportionally to their existing shares and dividends, without charging them.
Companies may choose to issue bonus shares even with sufficient liquidity to avoid high dividend distribution taxes imposed on them. This strategy helps companies manage their capital structures and fulfill shareholders' expectations without incurring additional tax burdens.
Bonus shares should not be confused with rights issues. While bonus shares are given "free" to shareholders, rights issues involve the offering of additional shares to existing shareholders at a discounted rate, which they need to purchase.
A bonus issue of shares follows a constant ratio formula, where a fixed number of shares is allocated to shareholders based on the number of shares they already possess. For instance, if a company declares a bonus issue in the ratio of 2:1, shareholders will receive two bonus shares for each share they hold.
There are several advantages associated with bonus shares. They enhance shareholder confidence in a company's ability to handle larger equity, fostering goodwill among shareholders. Although the share value decreases due to the increased number of shares after a bonus issue, it offers an attractive opportunity for investors. Bonus shares can yield profits when traded in secondary markets, especially when a company experiences significant profitability.
To be eligible for bonus shares, shareholders must own the company's shares before the record date, which is set by the company. Any shares purchased on or after the ex-date won't qualify for bonus share issuance.
In conclusion, the issuance of bonus shares reflects a company's confidence in its future profitability and its commitment to shareholders. It's a mechanism to equalize assets, maintain goodwill, and enhance shareholder value without directly impacting the company's overall worth.
Understanding the intricacies of bonus shares, shareholder entitlement, and corporate actions is crucial for investors navigating the stock market, especially when dealing with aspects like dematerialized accounts (Demat accounts) and stock transactions.
Additionally, exploring related articles, such as "How to Open a Demat Account Without a Broker," "Factors to Keep in Mind While Opening a Demat Account," or "Factors to Consider When Opening a Demat Account," can provide further insights into managing investment portfolios and navigating financial markets effectively.
