Bonus Issue

A bonus issue is a corporate action where a company provides additional shares to its existing shareholders at no extra cost. This is typically done to increase retail participation in the stock and enhance liquidity in the market.

What is a Bonus Issue?

A bonus issue increases the number of outstanding shares in the market without altering the market capitalisation of the company. Companies typically issue bonus shares using their profits or existing share reserves. 

This strategy is often employed to make the stock more affordable and accessible to smaller investors, thereby encouraging greater retail participation. Additionally, issuing bonus shares enhances the stock’s liquidity in the market, making it easier for investors to buy and sell shares.

How to Calculate Bonus Share?

The bonus issue is calculated based on the bonus ratio announced by the company. The ratio determines how many additional shares a shareholder receives for every existing share held.

Bonus Shares Formula

For example:

• In a 1:1 bonus issue, an investor holding 100 shares will receive 100 additional shares.
• In a 2:1 bonus issue, an investor holding 100 shares will receive 200 additional shares.

Although the number of shares increases after the bonus issue, the total investment value remains unchanged because the share price adjusts proportionately.

Types of Bonus Shares

Companies may issue bonus shares in different forms depending on their financial strategy and shareholder objectives.

Fully Paid Bonus Shares

In this type, shareholders receive fully paid additional shares without paying any extra amount. These shares are issued from the company’s reserves or retained earnings.

Partly Paid Bonus Shares

Partly paid bonus shares are issued to shareholders with partial payment obligations still pending. Shareholders may need to pay the remaining amount in the future as specified by the company.

Why Do Companies Issue Bonus Issues?

Companies issue bonus shares to make their stock more affordable for small investors by lowering the price per share and improving liquidity in the market. It is also a way to reward investors and demonstrate the company’s financial strength.

When a company issues bonus shares, the stock price drops proportionately. For example, Reliance Industries announced a 1:1 bonus issue on September 5, 2024. Following the announcement, the stock price was adjusted from 3,000 rupees to 1,500 rupees. Although the investment value of shareholders does not change, as they now hold more shares, the move increases liquidity in the market, making it easier for investors to trade.

A bonus issue lowers the stock price, making it affordable and boosting trading activity. For Reliance Industries, this likely increased investor participation and improved liquidity.

Advantages Of Bonus Issue

This strategy of issuing bonus shares comes with several advantages for both the company and its shareholders. Here are the key benefits of a bonus issue:

Increases retail participation:

Increasing the number of outstanding shares in the market enhances liquidity and reduces the stock price, making it more appealing to retail investors. A lower share price also allows investors to acquire more shares, improving accessibility and participation.

Indicators of Financial Health

When a company issues bonus shares, it indicates that it has adequate share reserves or profits to reward its existing shareholders. It also reflects the company’s strong financial position and its confidence in continuing growth and adding value for its shareholders.

Alternative to paying dividends

Smaller companies issue bonus shares when they have extra profits to attract investors instead of giving regular dividends. Bigger companies also issue bonus shares when their profits are not regular to build trust with their shareholders. This rewards shareholders and makes the stock easier to trade.

Favourable Tax Treatment

In the Indian stock market, bonus shares are not taxed at the time of issue, making them more attractive than cash dividends, which are taxed at the investor’s applicable income tax rate. However, investors must pay capital gains tax on bonus shares when they sell them, depending on the holding period and the gains made.

Disadvantages Of Bonus Issue

While bonus issues offer several advantages, they also come with certain drawbacks that investors and companies need to consider. Here are some key disadvantages of bonus issues:

Opportunity Cost

When companies issue bonus shares to their investors using excessive profits, these profits could have been utilised for other purposes that might add greater value to shareholders. For instance, retained earnings could be used for strategic acquisitions or purchasing new equipment and machinery to enhance business operations and future growth.

Negative Impact On Dividends

When companies issue bonus shares, it does not bring in any cash, which might reduce their ability to pay dividends in the future, potentially disappointing some shareholders. Additionally, some investors may worry that the company might prioritise issuing bonus shares over providing cash dividends in the long run.

No immediate financial benefit

Dividends are paid to investors upfront, whereas bonus issues to shareholders reduce the share price proportionately to the additional shares issued. For example, assume an investor buys 100 shares of TCS stock at ₹3,000 each, and the company announces a 1:1 bonus issue. After the bonus issue, the investor now holds 200 shares (100 original shares + 100 bonus shares). 

As a result of the additional shares added to the market, the share price adjusts to ₹1,500 each (₹3,000 ÷ 2). This does not provide the investor with any immediate financial gain, as the total investment value remains the same.

Stock Splits vs. Bonus Shares

A table summarising the difference between a stock split and a Bonus share

Taxation on Issue of Bonus Shares

Bonus issue generally does not attract tax at the time the bonus shares are issued in India. However, taxation may apply when investors sell those shares later.

Here are some key tax considerations:

Conclusion

A bonus issue is a corporate action where companies reward shareholders by issuing additional shares, improving liquidity, and making the stock more affordable for retail investors. It reflects the company’s financial strength and confidence in growth, offering a favourable alternative to dividends with tax advantages at the time of issue.

However, bonus shares come with drawbacks, such as no immediate financial benefit, reduced dividend-paying capacity, and the potential opportunity cost of not using profits for other strategic investments. Understanding the key differences between bonus shares and stock splits helps investors make informed decisions. Overall, bonus issues are a valuable tool for companies to attract investors and maintain shareholder trust while balancing their financial strategies.

Frequently Asked Questions (FAQs)

What is the bonus issue? Is it the right issue?

A bonus issue gives free extra shares to existing shareholders, while a rights issue lets them buy more shares at a discount.

When will bonus shares be credited to the demat account?

Bonus shares are usually credited to shareholders’ demat accounts within a few days after the record date, and the approval process is completed by the company and stock exchanges.

The exact timeline may vary depending on company procedures and regulatory approvals.

What is a bonus in the share market?

A bonus in the share market refers to additional shares issued by a company to its existing shareholders at no extra cost, based on a predetermined bonus ratio.

How to claim a bonus share?

Investors do not need to apply separately to claim bonus shares. If they hold shares before the ex-bonus date and are eligible on the record date, bonus shares are automatically credited to their demat account.

Why are bonus shares issued?

Companies issue bonus shares to:

• Reward existing shareholders
• Improve stock liquidity
• Increase retail participation
• Make shares more affordable
• Reflect financial strength and confidence in future growth

What are some bonus share examples?

Several Indian companies have announced a bonus issue to reward shareholders and improve market liquidity. Some well-known examples include:

• Reliance Industries announced a 1:1 bonus issue in 2024, where shareholders received one additional share for every existing share held.
• Infosys has issued bonus shares multiple times in its history, including a 1:1 bonus issue to reward long-term shareholders.
• Wipro has historically announced bonus issues to improve retail participation and increase liquidity in the stock.
• Tata Consultancy Services announced a 1:1 bonus issue in 2018, rewarding existing shareholders with additional shares.
• HCL Technologies has also issued bonus shares in the past as part of shareholder reward strategies.

What is the eligibility for bonus shares?

To receive bonus shares, investors must own the company’s shares before the ex-bonus date and remain eligible on the record date announced by the company.

What happens to the share price after the bonus issue?

The share price drops in proportion to the bonus ratio, but the total value of your investment stays the same.

Does a bonus share double your money?

No, a bonus share does not double your money right away. It only increases the number of shares you own.