Bonus shares are free additional shares that a company may decide to issue to its existing shareholders in a certain proportion to the current holding.
Or is it merely a company’s way of creating a buzz around its stock?
MUMBAI: Bonus shares are free additional shares that a company may decide to issue to its existing shareholders in a certain proportion to the current holding. So, if a company comes out with a 1:1 bonus issue, an investor gets one additional share for every existing share that he holds in the company.
A company has a certain amount of reserves, which it has built up over the years, by retaining a proportion of the profit and not giving it out as a dividend. While issuing bonus shares, the company converts a part of these reserves into shares. So, in the strictest sense, bonus shares are really not free.
Hence, at a very basic level, it is an accounting entry that moves money from one accounting head to another.
If a company declares a 1:1 bonus, the number of shares in the stock market would double and accordingly, the stock price should halve. Why then do so many companies issue bonus shares? And why do investors get so excited about it?
The answer lies in the fact that when a company issues bonus shares the market takes it as a signal that the present good run of the company will continue in the days to come. The company management would not have distributed these shares if it was not confident of distributing dividends on all the shares in the days to come.”
Let us say a company announces a 1:1 bonus. The closing price of the stock on that day was Rs 643.95. After that, the price of the stock started going up. It closes on Rs 720 on the record date. The next day, the stock goes ex-bonus, i.e. the bonus shares become available in the market. So, theoretically, the stock should have opened at around Rs 360 (Rs 720/2). But, what if it opens at Rs 368.50?
Investors feel that bonus is a company’s way of signalling that the good times are likely to continue.
Also, with the market price of the stock falling and with more shares in the market, it becomes much easier to buy and sell the stock. This gives the stock more liquidity.
But, one needs to be careful. The promoters of penny stocks can resort to issuing bonus shares to create a buzz around the company.
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