Bonus Shares: Meaning, Types, Eligibility, and More

In the world of investments, bonus shares hold significant importance as a way for companies to reward their shareholders. They represent a form of corporate action that benefits both companies and investors alike. This comprehensive guide will walk you through the meaning of bonus shares, how they are issued, their advantages and disadvantages, and much more.

What is Bonus Share in Stock Market?

Bonus shares are additional shares distributed by a company to its existing shareholders at no extra cost, based on the number of shares they already own. These shares are issued by converting the company’s retained earnings or reserves into share capital, without requiring shareholders to pay anything.

The issuance of bonus shares typically signals financial confidence and is often seen as a substitute for cash dividends, especially when companies prefer to retain cash for operations or expansion.

Bonus Shares Example

Let’s take a simple example to understand the concept:

Imagine you own 100 shares in a company, and the company announces a 2:1 bonus share. This means for every 1 share you own, you will receive 2 additional shares. Post issuance, you will hold 300 shares (100 original shares + 200 bonus shares). While your total number of shares increases, the price per share adjusts proportionally, keeping the investment value the same.

Why Do Companies Issue Bonus Shares?

Companies issue bonus shares for a variety of reasons, such as:

• Enhancing Liquidity: Increasing the number of shares in circulation lowers the price per share, making them more affordable and liquid.

• Capitalization of Reserves: Instead of distributing cash as dividends, the company converts reserves into share capital, strengthening its balance sheet.

• Encouraging Retail Participation: A reduced stock price post-issuance attracts more retail investors, broadening the shareholder base.

• Rewarding Shareholders: Bonus shares are a way to reward long-term investors, fostering trust and loyalty.

• Adjusting Share Price: High-priced stocks may discourage small investors. Issuing bonus shares adjusts the stock price to a more accessible level.

Types of Bonus Shares

There are primarily two types of bonus shares:

1. Fully Paid Bonus Share

These are issued without requiring shareholders to pay anything further. They are funded from the company’s reserves, such as:

• Retained earnings

• Securities premium account

• Capital redemption reserves

2. Partly Paid Bonus Shares

These apply to shares that were not fully paid for at the time of issuance. Bonus shares in this category adjust the unpaid amount, converting the shares into fully paid ones.

Eligibility for Bonus Shares

To be eligible for bonus shares, shareholders must meet the following criteria:

• Ownership Before Record Date: You need to hold the shares in your demat account by the company’s record date.

• Purchase Before Ex-Date: If you buy shares on or after the ex-date, you won’t be eligible for bonus shares.

• Demat Account: The additional shares are credited directly to your account, provided you meet the above conditions.

How to Calculate Bonus Shares?

The calculation is straightforward and depends on the bonus ratio announced by the company. For instance:

• Bonus Ratio: 3:1 (Three bonus shares for every one share held)

• Shares Held: 100

• Bonus Shares Received: 100×3=300

• Total Shares After Bonus: 100+300=400

The price per share adjusts inversely to the number of shares issued to maintain the investment value.

Advantages of Bonus Shares

For Shareholders

• Increased Shareholding: Shareholders receive additional shares, increasing their ownership stake.

• No Immediate Taxation: Bonus shares are not taxed when received; however, capital gains tax applies when sold.

• Long-Term Benefits: For investors with a long-term outlook, bonus shares can lead to significant capital appreciation.

For Companies

• Retains Cash Reserves: Bonus shares allow companies to reward shareholders without depleting cash reserves.

• Enhances Liquidity: The increased number of shares improves trading volume and accessibility.

• Market Perception: Issuing bonus shares showcases financial strength and boosts investor confidence.

Disadvantages of Bonus Shares

For Shareholders

• Dilution of Earnings Per Share (EPS): The number of shares increases, but the profits remain constant, leading to a lower EPS.

• No Immediate Financial Gain: Unlike dividends, bonus shares do not provide immediate cash benefits.

For Companies

• No Cash Inflow: Bonus shares are issued using existing reserves, generating no additional funds for the company.

• Administrative Costs: Managing and issuing bonus shares involves regulatory and administrative expenses.

• Potential Misinterpretation: Frequent bonus issues might signal the inability to pay dividends, raising concerns about the company’s liquidity.

Can You Sell Bonus Shares?

Yes, bonus shares can be sold once they are credited to your demat account. The process typically takes a few days post-issue, following the allotment of a new ISIN (International Securities Identification Number).

How Are Bonus Shares Different from Stock Splits?

While both bonus shares and stock splits involve an increase in the number of shares, they are fundamentally different:

Conclusion

Bonus shares are a win-win for both companies and shareholders. They allow companies to reward loyalty while retaining cash for growth. For investors, bonus shares offer an opportunity to increase their holdings and potentially benefit from long-term capital appreciation. However, it’s crucial to understand the disadvantages and evaluate them in the context of your investment strategy.

Whether you’re an existing shareholder or planning to invest in a company likely to issue bonus shares, keeping an eye on record dates, bonus ratios, and market dynamics is essential.