Bonus shares are additional stocks that companies provide to their existing shareholders, usually free of charge. These shares are often distributed as a “bonus” from the company’s profits or reserves, giving shareholders a larger stake in the company without needing to invest more capital.
What Are Bonus Shares?
Bonus shares, also referred to as “scrip dividends” in some regions, are shares that companies issue to their current shareholders without cost, based on a specified ratio. For example, in a 1:1 bonus issue, shareholders receive one additional share for each share they already hold. This means if a shareholder owns 100 shares, they will receive 100 more, doubling their holding to 200 shares.
Issuing bonus shares doesn’t change the company’s market capitalisation or directly increase shareholder wealth. Although shareholders end up with a higher number of shares, each share’s value typically decreases, balancing out the overall value of the investment.
Why Companies Issue Bonus Shares
Companies may issue bonus shares for various reasons:
1. Rewarding Shareholders: Issuing bonus shares rewards shareholders by giving them additional ownership in the company. This gesture reflects the company’s positive financial position, particularly if it has sufficient profits or reserves.
2. Increasing Liquidity: By adding more shares to the market, bonus issues can make shares more affordable and accessible, which can attract more investors and boost trading activity.
3. Optimising Capital Structure: Bonus shares allow companies to adjust their capital structure by moving funds from the reserves account to the share capital account. This transfer shows a balanced financial structure and can maintain investor confidence.
4. Making Shares More Affordable: When share prices are high, it can deter small investors. Issuing bonus shares typically reduces the price per share, making the stock more appealing and affordable to a wider range of investors.
5. Signalling Growth and Confidence: A bonus issue signals that the company is confident about its future earnings potential. This can have a positive impact on the market’s perception of the company and can increase investor interest.
How Bonus Shares Work
Issuing bonus shares usually involves the following steps:
- Bonus Ratio Announcement: The company’s board announces the bonus shares and specifies the ratio. For example, a 2:1 bonus means shareholders will receive two additional shares for each share they own.
- Record Date: The company sets a record date, which determines who is eligible for the bonus shares. Only shareholders who hold shares on this date are eligible.
- Ex-Bonus Date: Typically one or two days before the record date, the ex-bonus date is the last day for shareholders to qualify for the bonus. Investors who purchase shares after this date do not qualify for the bonus issue.
For instance, if a company declares a 2:1 bonus and a shareholder owns 100 shares, they’ll receive an additional 200 shares, making their total holding 300 shares. However, since the company’s overall market value hasn’t changed, the share price usually adjusts downwards after the issuance.
Impact on Shareholders
While bonus shares can benefit shareholders, they have specific effects:
1. No Immediate Wealth Change: Although the number of shares increases, the value per share typically decreases. The overall value of a shareholder’s investment stays the same immediately following the issuance.
2. Potential for Future Dividends: With more shares, shareholders may receive higher dividends in the future if the company continues to pay dividends on the increased capital base. However, this depends on the company’s profitability and dividend policy.
3. Tax Considerations: In many jurisdictions, bonus shares aren’t taxable at the time of issue. However, when shareholders sell them, capital gains tax applies. The original cost of the shares (usually zero) will be a factor in calculating capital gains tax.
4. Unchanged Voting Power: Bonus shares increase the total number of shares, but they don’t affect the percentage ownership or voting power of individual shareholders.
5. Psychological Impact: Receiving bonus shares can create a perception of additional value, giving shareholders a sense of satisfaction and fostering loyalty, even though the actual value hasn’t changed.
Advantages of Bonus Shares
- Boosting Investor Confidence: Issuing bonus shares shows the company’s solid financial health, which can enhance investor confidence.
- Increased Market Accessibility: By lowering the price per share, bonus shares make stock more accessible to smaller investors, potentially increasing market participation.
- Tax Efficiency: In regions where bonus shares aren’t taxed upon receipt, they’re a tax-efficient way to reward shareholders compared to cash dividends.
Limitations and Potential Drawbacks
While bonus shares have benefits, they come with limitations:
- No Immediate Cash Benefit: Unlike cash dividends, bonus shares don’t provide an immediate cash benefit. Shareholders might have to wait for future dividends or capital gains for returns.
- Reduced Earnings per Share (EPS): With a higher share count, the company’s EPS might decrease because earnings are spread across more shares. This can influence market perceptions of the company’s performance.
- Potential Stock Volatility: The adjusted share price post-issue can lead to increased volatility, particularly if the stock lacks sufficient investor interest at the lower price level.
[The writer possesses a fascination with the world of business and the intricacies of stock markets]
