Difference Between Bonus Issue and Stock Split

Sometimes companies increase the number of shares investors hold through bonus issues or stock splits. These moves affect the number of shares and their price, but they do not directly increase or decrease your investment value.

Here we take a look at exactly what a bonus issue and a stock split are, why companies announce them, and what they actually mean to an investor.

Key Highlights:

• Bonuses are additional shares given to investors for free, with no effect on the face value.
• Splits are additional shares credited to shareholders by diluting the face value.
• In a stock split, existing shares are divided into smaller units by reducing the face value. 

What is a Bonus Issue?

When you buy shares of a company, you become a partial owner of that business. 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.

What is a Stock Split?

A stock split 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 remains the same because the share price declines.

Difference Between Bonus Issue vs. Stock Split 

Although bonus issues and stock splits may look similar at first, they work differently behind the scenes. Let’s compare them in simple terms:

How does a Bonus Issue and Stock Split Work?

Bonus Issue

A bonus issue is when a company gives you shares for free. This increases the number of shares you own. The total value of your investment stays the same.

Here's how it works:

Step 1: Company Announces a Bonus Issue: The company announces it will issue additional shares. For example, they might say that for every 1 share you have, you get 1 share for free.

Step 2: Additional Shares Are Credited: The shares are credited to your account.

Step 3: Share Price Adjusts Automatically: When the company issues shares, the price of each share goes down. This happens so that the total value of your investment stays the same.

Step 4: Your Total Investment Value Remains the Same: Now that you have the shares in your demat, the total value of your investment remains the same.

Example: Suppose you own 100 shares priced at ₹1,000 each. Your total investment value is ₹1,00,000, and the company announces a 1:1 bonus.

• Existing Shares = 100
• Bonus Shares = 100
• Total no of Shares = 200
• Adjusted Share Price = ₹500 per share

So, 200 × ₹500 = ₹1,00,000

The number of shares doubles, but the total investment value remains constant.

Stock Split

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 = ₹10, trading at ₹3,000, and your total 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), and your investment value is 10 shares × ₹300 = ₹3,000.

The company’s market capitalization (the total value of all shares) remains unchanged. 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 Bonus Issues and Stock Splits?

Bonus Issue

Companies offer bonuses to recognize employee contributions, encourage better performance, and align individual efforts with business goals.

• Reward Shareholders: Bonus shares satisfy the need to avoid paying cash dividends while rewarding investors.
• Utilize Excess Reserves: Well-run companies often convert some of their excess reserves into capital stock.
• Increase Liquidity: Issuing new shares puts more shares in the market, increasing trading activity.
• Reflect Financial Strength: Bonus issues are often seen as a sign of business strength when earnings meet expectations.

Stock Spilt

Companies usually announce a stock split to make their shares more accessible and improve market participation. Here are the key reasons:

• Makes Shares More Affordable: A lower share price makes it easier for more investors to buy the stock.
• Enhances Liquidity: Lower-priced shares typically attract more buyers and sellers, resulting in greater trading activity and better execution.
• Indicates Management Confidence: A stock split can signal that the company anticipates substantial, continued growth.
• Attracts More Investors: Lower-priced shares may appear more appealing and encourage greater investor interest.

How will Company Financials affect?

When a company issues bonus shares, it moves money from its reserves to its share capital. This process is called capitalization 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 (the 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.

Things to Consider about Bonus Issues and Stock Splits

Just like many other investors, you are thrilled at first by bonus issues and stock splits. You receive shares, and it is a nice thing to have. But let's face it, they don't actually create wealth or poverty in a vacuum. Here's the thing:

• Better Market Perception: 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.
• Signal of Business Confidence: 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

The main reason for bonus issues and stock splits is to make it easier for people to trade shares. They increase the number of shares held by investors and reduce the price of each share. They also do not change the company's ownership stake. This is because bonus issues and stock splits make shares cheaper and more accessible to investors.