What are Bonus Shares? Types, Reasons of Issuing & Advantages (2024)

When we talk aboutwhat are bonus shares, the first thing that comes to my mind is the quote –The best things in life are free.Well if we see, bonus shares are also offered for free. But, does that mean they are best for our portfolio too? That’s exactly what we are going to explore today.In this article:

• What are bonus shares?
• What is record date?
• What is ex-date?
• Calculation of bonus shares
• Reasons for issuing bonus shares
• Types of bonus shares
• Legal requirements for bonus issues
• Advantages of bonus issues from the investor’s point of view
• Disadvantages of bonus issues
• Tax Implication of bonus shares
• Upcoming bonus shares in 2022

What are Bonus Shares?

A bonus share is the additional share that a company gives to its shareholders. These shares are offered for free. It is a win-win situation for both, as investors enjoy free shares and companies earn faith of existing shareholders in the operations of the company.Generally, bonus shares are also known as scrip dividends. It means that instead of paying dividends in cash, the company prefers distributing bonus shares to the shareholders. This is done in a certain ratio. For example, if a company declares bonus in 1:5 ratios. It means that the existing shareholder will get one bonus share for every five shares held.

Now that you know what are bonus shares. Let’s move ahead and understand the two terms that you will often hear when it comes to bonus issues.

1. Record date
2. Ex-date

What is Record Date?

The record date is the predetermined cut-off date by which you must hold the shares in yourDemat account. This date is set so that the company could identify the eligible shareholders and distribute bonus shares accordingly.The shareholders who own share in theirDemat accounton the record date will be eligible for bonus shares distributed by the company.

What is Ex-date?

Usually when you buy shares of a company, it gets credited into yourDemat accountin three working days. So the ex-date is the cut-off date by which you must buy the shares to get eligible for bonus issue. Usually it is one set one working day prior to the record date.Conversely, if you want to liquidate your position and still be eligible for the bonus shares then you need to hold the share till the ex-date.

Reasons for Issuing Bonus Shares

1. Company issues bonus shares to capitalize their free reserves, increases the earning per share (EPS) and paid up capital and reduce the reserves and surplus of the company.
2. Another aim of issuing bonus shares is to encourage and increase participation of retail investors in the stock.

Let us understand how the price changes after the issuance of bonus shares.

Change in the Prices After Issuance of Bonus Shares

The share prices fall considerably in proportion of bonus shares allotted. The equity share capital remains unchanged while the number of shares outstanding increases. Let’s take an example. Suppose, a company’s share price is trading at Rs. 100. The number of shares outstanding is 10 lakhs. So the equity share capital of the company rounds up to Rs. 10 crores. If the bonus shares are declared in 1:1 ratio then, the market capital remains unchanged while the number of shares increases from one lakh to 20 lakhs and price reduces to Rs 50 per share. This is because for every share held by an investor a bonus share is allotted for free. Hence, the price of the share decreases proportionately to accommodate the change.

Types of Bonus Shares:

There are two types of bonus issues:

1.Fully Paid Bonus Shares

When bonus shares are distributed free of cost in the proportion of shares held by the investor, it is called fully paid bonus shares.

2.Partly paid bonus shares

First let us understand what is a partly paid share?A partly paid share is where you don’t have to pay the entire issue price of the share at once. Instead, the company announces call dates on which you must pay the outstanding amount.In partly paid bonus shares, instead of announcing the call date the company converts those partly paid shares into fully paid up shares.

Legal Requirements for Bonus Issues

Bonus shares can be issued only after a period of 12 months from the issue of shares for consideration. It can be issued only out of free reserves. This is the reserve created out of profits realised in cash.The bonus issue has to be issued as fully paid and only two bonuses can be issued in a period of 5 years. The balance of reserves after the bonus issue should be 40% of the post issue capital.

Advantages of Bonus Issues from the Investor’s Point of View

• There are no tax implications on receipt of bonus shares for investors.
• It is specifically beneficial for investors who are looking to make investments for a long term horizon.

When the company declares dividend in the future, the investor who has received bonus shares will getdividendon the additional share as well. So your earnings from dividends would be higher. Let us see how bonus issues can enhance the performance of your portfolio in the long term with the help of a real life example ofWipro.

As we just saw, an initial investment of Rs. 10,000 for purchasing 100 shares of Wipro in 1980s would turn into whopping Rs. 741 crores in 2021. This is the power of corporate actions if the shares are held for the long term. So, ifWiproannounces a dividend of even Rs 1 per share, you would have earned 2.56 cores only for holding the shares since 1980.

Advantages of Bonus Issues from the Company’s Point of View

• The liquidity of the share increases as there is an increase in the number of outstanding shares.
• Reduction in price per share will make the share an attractive investment option for investors.
• The issue of bonus shares will enhance the company’s image in the market as existing shareholders will value the management of the company.

Disadvantages of Bonus issues

Let’s look at a few drawbacks of the issuance of bonus shares.

• Issuing bonus shares might reduce earnings per share which will make the stocks less attractive for investors.
• The company does not gather any additional cash on issuing bonus shares. So, the ability to raise money byfollow-on public offersreduces.
• An investor may require cash to fulfil their financial obligations or meet their financial goals. They may expect liquidity in the form ofdividends. The receipt of bonus shares may just put their obligations and goals in danger. The investor can surely meet these liquidity objectives by selling the bonus shares in the open market, but this would reduce their stake in the company proportionately.
• Investors must be careful of tax implications in case of selling bonus shares. For example, if you sell shares immediately after ex-bonus a tax liability of 15% would arise on the sale proceeds. This tax liability could be much higher than the actual gain in the shares.

Risk of Auction of Bonus Shares Sold Without Actual Receipt of Shares inDemat Account

In stock splits the shares with a new face value are credited immediately. But in the case of bonus issue, the shares are credited after a few days (usually 15 days) after the ex-date. So, the investor cannot sell the share before it is credited into yourDemat accountas it may lead to auction.Also, while you study the chart of a particular share, please make sure that the fall in price is a result of bonus shares issued. Let’s understand this with an example.

Chart not adjusted for Bonus Shares – ITC Stock Chart – 1 Year Ending September 2016

Chart adjusted for Bonus Shares – ITC Stock Chart – 1 Year Ending September 2016In the above two charts ofITC Ltd. The stock went Ex-Split on 01-07-2016 with a bonus issue of one bonus share allotted for every two shares held. Accordingly, the price was adjusted and fell from Rs. 360 odd levels (pre bonus) to Rs. 240levels (post bonus). As youcan see in the first chart, the prices have not been adjusted for the bonus in the charts. Therefore, we can see a huge gap. Whereas, in the second chart the price has been adjusted for the bonus issue and therefore we see no irregularity in prices and see a normal price pattern.If any trader was to apply any technical analysis methods such asmoving averages,RSI,Bollinger bands, etc. in the first chart the results would be absurd and would lead to incorrect conclusions.Hence, it is very important that traders ensure that the charts have been adjusted for bonusbefore applying anytechnical analysisstudies. The adjustment in charts needs to be done in bothpriceand volume before analysis.

Tax Implication of Bonus Shares

Under the Indian Income Tax Act, the cost of the bonus shares is considered as zero. This means that when bonus shares are sold, the entire selling price is considered as capital gains.

• If bonus shares are held for more than 12 months from the date of being credited in theDemat accountthen they shall be considered as held for long term and the capital gains would exempt from taxation.
• If bonus shares are held for lessthan 12 months from the date of being credited in the Demat account then, they shall be considered as held for shortterm and shortterm capital gains would be levied at 15%.

Upcoming bonus shares in 2022

There are some upcoming bonus shares in 2022 to keep an eye on. If you are not holding these shares, you can still be eligible for the bonus issues if you purchase its shares before the ex-date as discussed above.

Summary

• Bonus shares are additional shares provided at free of cost.
• Record date is the cut-off date by which the investor must hold shares to be eligible for bonus shares.
• Ex-date is the cut-off by which an investor must purchase shares for the shares to be deposited on the record date.
• Reason for issuing bonus shares can range from providing dividends to the shareholder in the form of stock due shortage of cash to increasing retail investors’ participation and expand the equity base.

Conclusion

If you’re a long-term investor then bonus shares are explicitly valuable as seen in the example ofWipro. But, to invest in bonus shares you need to hold the shares in yourdemat account on the ex-date. So, to never miss a golden opportunity all you need to dois open a Demat account at Samcoand get access to our robust trading platformSamco App. Our online trading application keeps you up to date on all news related to the stock market and also provides easy access to buying and selling shares in just a few clicks.So,open a free demat and trading account now!