For stock market investors, it is bonanza time from bonus shares. This year, over two dozen companies, including Wipro, ICICI Bank and Biocon, have announced bonus shares, and more are likely to do so in the near future. More number of bonus shares given by companies is an indication that they are confident about the business activities and can generate value for investors in the future. A bonus does not change anything financially in the company, but the stock price gets reduced. In fact, bonus shares are additional shares issued by a company to its existing shareholders for free. It is based on a ratio of the shares currently owned by the shareholders.
Recently, the board of directors of Motherson Sumi had recommended to issue bonus shares in the ratio of one bonus shares against the two existing shares. Similarly, ICICI Bank board had recommended a bonus in the ratio of 1:10 – one bonus share for every 10 shares held by investors. Godrej Consumer Products and Petronet LNG, too, announced a 1:1 bonus. Biopharmaceutical major Biocon, too, had recommended issue of bonus shares in the proportion of 2:1 – two bonus equity shares of Rs 5 each for every one fully paid up equity share, each held on record date.
Boosting trading volume
Bonus shares help in boosting trading volume of the stock at the bourses as more number of shares are traded. While the profit remains the same, the number of shares goes up. So, after a bonus issue, the number of shares available in the market goes up. For instance, if company A had 10 million shares, with a bonus issue of 2:1, the total number of shares will become 30 million. As a result of the increase in the increased number of shares, the earnings per share of the company will drop. Under the Companies Act, a company can use only any one or all of the following reserves — free reserves, securities premium account and capital redemption reserve — for issue of bonus shares.
After bonus shares are issued, the amount available to the company under reserves/surplus comes down according to the amount of the bonus paid. Also, the share capital of the company goes up by the same amount. This is generally known as capitalisation of reserves. Most of the times, companies declare bonus shares to encourage more retail participation in equities. Moreover, when price per share of a particular company is trending high and retail investors find it difficult to buy, increase in the number of shares reduces the price per share of the stock. This can help retail investor to enter the market at a lower rate.
In the 2016-17 Union Budget, the Centre had levied a 10% tax on income by way of dividend over Rs 10 lakh on individuals, Hindu Undivided Family and partnership firms. Moreover, for the 2017-18 Budget, the government had included private trusts within this tax ambit. By giving bonus issue to shareholders, instead of a higher dividend, companies save on dividend distribution tax. Analysts say if investors are planning to buy shares of companies which are going to announce bonus issues, then they should also look at the fundamentals of the company. In the long run, the share price of the company will only rise if the fundamentals of the company are strong and have growth prospects in the future.