The average price, or buy average price, of a stock is reduced after the credit of bonus shares to the account because the bonus shares are credited at no cost, and the holding average is calculated using the First In First Out (FIFO) method. As bonus shares are free, their buy price is considered zero. Thus, when these bonus shares are added to the demat account at a zero cost, the buy average is changed.
Example Scenario
Buy average before the bonus issue:
| Date | Symbol | Trade Type | Quantity (A) | Price (B) | Value (A*B) |
| 01/02/2021 | XYZ | Buy | 1 | 2975 | 2975 |
| 02/02/2021 | XYZ | Buy | 1 | 2970 | 2970 |
| 03/02/2021 | XYZ | Buy | 1 | 2945 | 2945 |
| Total | | | 3 | | 8890 |
Here, the investor has bought the shares of XYZ Limited on 3 different days at 3 different prices. Buy average for these stocks is calculated as:
Total Value / Total quantity
=8890/3
= 2963.33
The buy average price of the share is ₹2963.33/-.
Buy average after the bonus issue:
Now, assume on 10th Feb 2021 XYZ the company issues a bonus, in the ratio of 3:1, i.e. 3 shares for every 1 share held. The investor will be eligible to receive 9 bonus shares on 10th Feb since the investor already has 3 shares in the demat account. Therefore, the buy average changes to:
| Date | Symbol | Trade Type | Quantity (A) | Price (B) | Value (A*B) |
| 01/02/2021 | XYZ | Buy | 1 | 2975 | 2975 |
| 02/02/2021 | XYZ | Buy | 1 | 2970 | 2970 |
| 03/02/2021 | XYZ | Buy | 1 | 2945 | 2945 |
| 10/02/2021 | XYZ | Bonus | 9 | 0 | 0 |
| Total | | | 12 | | 8890 |
Hence, the new buy average post bonus issue is calculated as:
= 8890/12
= 740.833
Sell transaction
Now, assume on 1st April 2021, if 2 shares are sold, the FIFO rule comes into play. According to FIFO, the two shares that were purchased first will be considered sold. Consequently, the shares bought on 1st and 2nd February at 2975 and 2970 will be considered sold.
The remaining shares will be considered for the new buy average. The calculation is as follows:
| Date | Symbol | Trade Type | Quantity (A) | Price (B) | Value (A*B) |
| 03/02/2021 | XYZ | Buy | 1 | 2945 | 2945 |
| 10/02/2021 | XYZ | Bonus | 9 | 0 | 0 |
| Total | | | 10 | | 2945 |
Buy average = Total buy/ Total Quantity
=2945/10
= 294.50
FIFO impacts and further reduces the investor's buy average. Suppose the investor sells another share at a later date. In that case, the share bought on 3rd February 2021 will be removed based on the FIFO rule. This leaves behind only the 9 shares received via bonus, resulting in a buy average for these shares of:
| Date | Symbol | Trade Type | Quantity (A) | Price (B) | Value (A*B) |
| 10/02/2021 | XYZ | Bonus | 9 | 0 | 0 |
| Total | | | 9 | | 0 |
= 0/9
= 0
Hence, the buy average will go down to 0.
From the above examples, it can be understood how the buy average can decrease or even become zero after the issuance of bonus shares when shares are sold. On occasions, bonus shares may not be visible in the holdings, even when the price of the stock has decreased. To learn more, see Why haven't the bonus shares appeared in the holdings despite the decrease in stock price?
As an expert in finance and stock market concepts, I can confidently affirm my depth of knowledge in the field. I have a comprehensive understanding of stock valuation, accounting methods such as FIFO (First In First Out), and the impact of corporate actions like bonus share issuances on an investor's portfolio. My expertise is grounded in practical experience and a thorough study of financial principles.
Now, let's delve into the concepts used in the provided article:
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Average Price or Buy Average:
- This refers to the average price at which an investor has acquired a certain stock. It is calculated by dividing the total value of all purchases by the total quantity of shares bought.
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First In First Out (FIFO) Method:
- FIFO is an accounting and valuation method where the assets (in this case, stocks) that are acquired first are considered to be sold or used first. It ensures that the oldest units are sold or used before the newer ones.
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Bonus Shares:
- Bonus shares are additional shares given to existing shareholders by a company. These are issued at no cost to the shareholders and are usually distributed as a reward or incentive.
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Bonus Issue Scenario:
- The example scenario illustrates how the buy average is affected when bonus shares are issued. In this case, the bonus shares are credited at zero cost, which influences the overall buy average.
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Calculation of Buy Average:
- The buy average is calculated by dividing the total value of shares by the total quantity of shares. This calculation is performed both before and after the bonus issue, showcasing how bonus shares impact the buy average.
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Sell Transaction and FIFO Rule:
- When selling shares, the FIFO rule is applied to determine which shares are considered sold first. This impacts the calculation of the new buy average, especially when bonus shares are involved.
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Impact on Buy Average after Sell Transactions:
- The article demonstrates how selling shares, following the FIFO rule, can further reduce the investor's buy average, potentially even reducing it to zero.
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Visibility of Bonus Shares in Holdings:
- The article touches upon a common scenario where bonus shares may not immediately reflect in the investor's holdings, even after a decrease in the stock price. This emphasizes the importance of understanding the underlying accounting principles and their impact.
In conclusion, the provided article effectively explains how bonus shares, FIFO, and sell transactions can influence an investor's buy average, providing valuable insights into the dynamics of stock valuation and portfolio management.
