Difference Between Bonus Issue and Stock Split

Bonus issues or stock splits are common corporate actions that can change the number of shares you own and the price of those shares, but they don’t always affect your wallet the way you might think. In this article, we’ll break down what bonus issues and stock splits are, how they work, their implications, and the key differences between them.

What is a Bonus Issue?

Imagine you own a part of a company by holding its shares. Now, the company is doing well, making profits, and has some extra cash (called reserves) saved up. Instead of giving you cash dividends, the company decides to reward you with more shares for free. This is called a bonus issue, also known as an equity dividend.

In a bonus issue:

• You get additional shares without paying anything extra.
• The number of shares you get depends on how many shares you already own and the ratio announced by the company.
• The total value of your investment stays the same, even though you have more shares.

How Does a Bonus Issue Work? Let’s Break It Down with an Example

Suppose you own 100 shares of a company, and each share is worth ₹10. Your total investment value is:

100 shares × ₹10 = ₹1,000

The company announces a 1:1 bonus issue. This means for every share you own, you get one extra share for free. So, after the bonus issue:

• You now own 200 shares (100 original + 100 bonus shares).
• But the share price adjusts to keep the value of your investment the same. The price per share drops to ₹5.

Your new investment value is:

200 shares × ₹5 = ₹1,000

Notice that your total investment value remains ₹1,000. You have more shares, but each share is worth less. This is because the company is essentially dividing its value across a larger number of shares.

Another example: If the company announces a 1:2 bonus issue, you get 1 extra share for every 2 shares you own. So, for your 100 shares, you’d get:

100 ÷ 2 = 50 bonus shares

You’d then have 150 shares, and the share price would adjust accordingly to keep your investment value the same.

Why Do Companies Issue Bonus Shares?

Companies issue bonus shares for the following reasons.

• Reward Shareholders: It’s a way to thank shareholders without paying cash dividends.
• Use Excess Reserves: Companies with strong profits often have surplus cash (free reserves). Issuing bonus shares uses these reserves to increase the company’s share capital.
• Increase Share Liquidity: More shares in the market can make the stock easier to buy and sell.
• Signal Financial Strength: A bonus issue often shows that the company is doing well financially, which can boost investor confidence.

What Happens to the Company’s Finances?

When a company issues bonus shares, it moves money from its reserves to its share capital. This process is called capitalisation of reserves. The company’s total value doesn’t change, but the number of shares increases, which affects a few key metrics.

• Earnings Per Share (EPS): Since there are more shares, the company’s profit is divided among more shares, so EPS decreases.
• Book Value Per Share: The book value (company’s net worth) is spread across more shares, so this value per share drops.
• Market Price Per Share: The share price adjusts downward to reflect the increased number of shares.

However, as a shareholder, your ownership percentage in the company stays the same, and the overall value of your investment doesn’t change. Plus, a bonus issue is often a positive sign that the company is financially healthy!

What is a Stock Split?

Now, let’s talk about a stock split. Imagine a pizza that’s too big for everyone to share easily. The chef cuts it into smaller slices, so there are more pieces, but the total amount of pizza stays the same. A stock split works similarly it increases the number of shares by dividing each share into smaller pieces, but the company’s overall value remains unchanged.

In a stock split:

• The face value of each share (its nominal value) is reduced.
• The number of shares you own increases in proportion to the split ratio.
• The total value of your investment stays the same because the share price adjusts downward.

How Does a Stock Split Work’s

Let’s say you own 1 share of a company with a face value of ₹10 and a market price of ₹3,000. The company announces a 1:10 stock split, meaning each share is split into 10 smaller shares.

Before the split:

• You own 1 share with a face value of ₹10, trading at ₹3,000.
• Your investment value is 1 × ₹3,000 = ₹3,000.

After the split:

• You now own 10 shares, each with a face value of ₹1 (₹10 ÷ 10).
• The market price per share drops to ₹300 (₹3,000 ÷ 10).
• Your investment value is 10 shares × ₹300 = ₹3,000.

The company’s market capitalisation (total value of all shares) remains the same. If the company had 1 lakh shares before the split, it now has 10 lakh shares, but the total value is unchanged.

Why Do Companies Do Stock Splits?

Stock splits are usually done to:

• Make Shares More Affordable: If a company’s share price is very high (say ₹3,000), smaller investors might find it hard to buy. Splitting the shares lowers the price, making it more accessible.
• Increase Liquidity: More shares at a lower price mean more trading activity, making it easier to buy and sell.
• Attract More Investors: A lower share price can draw in new investors, boosting the stock’s popularity.

What Happens to the Company’s Finances?

Unlike a bonus issue, a stock split doesn’t involve moving money between reserves and share capital. The company’s share capital, reserves, and market capitalization remain the same. Only the face value and number of shares change. This means:

• EPS and book value per share decrease because there are more shares.
• Market price per share drops in proportion to the split ratio.
• But your ownership percentage and investment value stay the same.

Bonus Issue vs. Stock Split: What’s the Difference?

While both bonus issues and stock splits increase the number of shares you own and lower the share price, they’re quite different in how they work and why they’re done. Let’s compare them in simple terms:

In simple terms:

• A bonus issue is like getting free extra slices of cake because the bakery made extra profits.
• A stock split is like cutting your cake slice into smaller pieces so it’s easier to share, but you don’t get more cake.

Why Should You Care About Bonus Issues and Stock Splits?

As an investor, bonus issues and stock splits can seem exciting because you get more shares, but they don’t make you richer (or poorer) on their own. Here’s why they matter:

• Psychological Appeal: More shares at a lower price can make the stock feel more attractive, potentially driving up demand.
• Liquidity Boost: Both actions increase the number of shares in the market, making it easier to buy and sell.
• Company Health: A bonus issue often signals a profitable company, while a stock split suggests the company wants to attract more investors.
• No Tax Impact: In many countries (like India), bonus issues and stock splits are not taxable events for shareholders, unlike cash dividends.

Conclusion

Bonus issues and stock splits are two methods of modifying the structure of shares in a company. A bonus issue increases the number of shares available by utilizing the company’s retained earnings, while a stock split divides existing shares into smaller units to enhance share liquidity. In both scenarios, the overall value of the investment remains unchanged, but the quantity of shares increases, resulting in a lower value per share.

For retail investors, these measures can make shares more accessible and attractive; however, they do not alter the underlying value of the company. Therefore, when you encounter a bonus issue or a stock split, you will understand the implications for your investment portfolio. Continue to educate yourself, remain inquisitive, and invest prudently.