Companies give bonus shares to the existing share holders by converting their reserves and surplus into shares. In a 2:1 bonus issue a share holder gets 2 free shares for every one share he holds (Don’t get confused. It’s correct). The additional shares come at free of cost but the price gets reduced proportionately.
For example, if you hold 100 shares of company XYZ whose market value is Rs 3000 per share and assume company XYZ has announced 2:1 bonus issue. On ex-date the price of XYZ comes around Rs1000 (It will be slightly greater than Rs 1000 usually. This price is called ex-bonus or post bonus price) and the additional 200 shares or bonus shares get credited to your account after few days. This is because the total number of outstanding shares increased 3 times but the earnings of the company is same. So the new EPS (Earnings Per Share) will be 1/3 rd of previous EPS and share price comes down proportionately.
One can observe that the total equity base of a company doesn’t get much affected with the bonus issue (Market price per share comes down and number of shares goes up keeping the product i.e. Market Capitalization same). In the above example the price may go over Rs 1000 because the liquidity increases because of lower price.
Companies announce bonus shares to
• Increase the number of active shares to get the correct valuation of shares
• Increase liquidity in the counter
Most of the times a bonus issue shows the healthiness of the company. Investors think that companies would continue to announce the dividends of same percentage on the face value as they did previously. So investors get benefited by a bonus issue.
Bonus activity doesn’t fetch multifold benefits to share holders (Some people think that they get free shares without any price change). It’s merely a balance sheet mathematical jugglery. Only liabilities section of balance sheet is modified. Reserves, surplus and stock come under liabilities from companies’ perspective. In a bonus issue a part or full portion of Reserves and Surplus moves to Stock, there by not affecting the balance sheet much.
Sathish Emmadi
Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.
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