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Bonus Issue

A bonus issue of shares is a corporate action whereby an organisation issues its existing shareholders with additional shares at nil cost in proportion to the existing shares held. This is often achieved by capitalization of part of the company's reserves or retained earnings. Bonus issues increase the number of outstanding shares, while market capitalization remains unchanged. The shareholders, while ending up with more shares, see the price of each share also drop in proportion, thus your total value holdings remain the same. This action is many times viewed as a way to reward shareholders and may improve the liquidity in the stock. Bonus issues are declared by a company to indicate that the future profits will also be good, or to bring the priced stock in an attractive trading group for the retail investors. Indirectly, though, it does not affect either cash flow or profitability of the company.

What is a Bonus Issue?

A bonus issue is an action taken by a firm in which it gives its current stockholders more shares at no cost to them based on the percentage of shares they currently hold in their demat. The company's reserves or retained profits are converted into equity to carry out this operation. A downward adjustment in the share price means that even though the shareholders acquire more shares, their total worth stays the same. Incentives for shareholders, increased stock liquidity, and, in certain cases, lower stock prices for a larger pool of investors are the driving forces behind the issuance of bonus shares. It doesn't impact the company's profitability or cash flow.

A company named ABC announced a 1:2 bonus issue, meaning shareholders received one additional share for every two shares they held. If an investor owned 200 shares before the bonus issue, they would receive 100 extra shares, increasing their total holdings to 300 shares.

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Why Do Companies Opt for a Bonus Issue?

Rewarding Shareholders

A bonus issue enables the company to reward the shareholders without giving any cash dividend. By issuing additional shares, the company gives value to the investors and retains cash for other purposes. It further demonstrates that the company is committed to the well-being of shareholder wealth, which may stimulate loyalty and possibly promote long-term holding of shares as investors achieve some advantageous element from the investment.

Enhancing Liquidity

The issuance of bonus shares by a company increases the supply of the share in the market, which in turn raises the trading velocity. Greater liquidity means that the stock is more liquid and can be traded with reduced bid-ask spreads. This would render the security more attractive to a wider group of investors, particularly to those institutional investors who desire liquidity.

Adjusting Share Price

The issue of bonus shares normally decreases share price by reason of increased supply while the market capitalization of the company remains constant. This also makes the reduced share price more attractive and affordable for small investors as the shareholder base becomes wider. This may also increase demand, therefore reducing fluctuations in the market value of the stock over time.

Optimising Capital Structure

Bonus shares can be issued by a company to convert retained earnings or reserves into equities. The firm itself can benefit by knowing its financial structure, which will portray more equity on its balance sheet. Smoothening the capital base will have a positive effect on the firm's financial ratios, for example, debt to equity, since the latter provides a better risk profile for both lenders and investors.

Signalling Strong Financial Health

A bonus issue is a signal of the company's good financial health. Every time a company announces the issuance of bonus shares, it only does so when the reserves in its account are good enough, and it feels confident about its sufficiently earned profits in the future. A positive sign like this could work on strengthening investor-investor trust and attract more new investors because this seems to promise stability and long-term profitability.

Improving Investor Perception

Bonus shares will reinforce investors' perception about the company that the management is confident about its growth prospects and its commitment to long-term deliverance of shareholder value. This improved perception will be reflected in increased demand for the stock, improvement in analyst views, and finally a higher price for the stock.

Features of Bonus Issue

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No Cash Outflow

A bonus issue does not involve any cash outflow on the part of the company. It only converts the existing reserves or retained earnings as share capital. This characteristic enables a firm to compensate its shareholders at no cost, hence not reducing their cash balance, yet it creates more value for them.

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Proportional Allocation

Bonus shares are issued to the concerned shareholders in a certain fixed proportion, as usually given-for instance, 1:2 or 1:3. Due to this type of allotment on a proportional basis, each and every shareholder receives additional shares in an identical manner, which means that their percentage ownership of the company remains unchanged. In this way, fair treatment would be provided to all shareholders irrespective of their total holding of shares.

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Impact on Share Price

Bonus share issuance tends to reduce the share price because the number of outstanding shares has gone up, but the market capitalization of the company remains the same. This adjusted lower price is relatively more affordable to a large number of investors, hence improving the market participation and liquidity.

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Non-Dilutive Nature

The bonus issue, unlike the issues of rights or new shares, does not dilute the percentage ownership of the existing shareholders. Since all the shareholders are given shares in a proportional manner, their stake in the company remains exactly the same. This non-dilutive feature is favourable to investors since it preserves their relative ownership and control of the company.

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Purpose of Bonus Issue

By giving away extra shares at no cost to current shareholders, bonus issues aim to reward current owners by increasing their total shareholding while preserving their ownership proportion. Through lower stock prices, which can draw in a wider pool of investors, this corporate activity assists corporations in increasing the liquidity of their stock. Companies can manipulate the share price to a more desirable level by distributing bonus shares, which frequently results in an increase in trading activity.

A bonus issue also conveys to investors the company's strength of finances and belief in future profitability, which is a positive indication. It preserves liquidity for upcoming operations and investments by enabling the business to capitalise on its reserves or retained earnings without using up all of its financial resources. In general, the bonus issue is a calculated tactic to raise marketability, enhance shareholder value, and improve the financial profile of the business without changing the total market capitalization.

How Do Bonus Issue Benefit Investors?

Bonus issues benefit investors in several meaningful ways, enhancing both their holdings and their perception of the company. First, investors receive additional shares for free, which increases their total shareholding without any additional investment. Although the share price usually adjusts downward to reflect the increased number of shares, the total value of the investment remains the same initially. However, the increase in the number of shares can lead to greater liquidity, making it easier for investors to buy and sell the stock.

Another benefit is that a bonus issue can make the stock more affordable to smaller investors by lowering the share price. This broader accessibility can increase demand for the stock, potentially driving up its value over time. Additionally, a bonus issue signals the company's confidence in its future profitability and financial health, which can positively influence investor sentiment and market perception.

Furthermore, bonus issues do not dilute the ownership percentage of existing shareholders since the new shares are distributed proportionally. This preservation of ownership is especially important for long-term investors who want to maintain their stake in the company. Overall, bonus issues offer a non-dilutive, cost-free way for investors to increase their shareholding, improve liquidity, and potentially benefit from future stock appreciation.

How do Bonus Issue Benefit Companies?

  • Enhances Marketability:
    By way of bonus issue, companies reduce the share price, which provides easier access for more people to invest in the company's stock. The increased accessibility may attract more investors, increase trading activity, and ultimately enhance marketability, leading to greater liquidity and, possibly, demand.
  • Boosts Investor Confidence:
    Normally, a bonus issue reflects the firm's soundness on financial issues and confidence in earnings in the future. This good signal possibly enhances investor confidence, whereby existing shareholders will hold on to the shares for a longer period of time, and new investors emerge, considering the bonus issue as a positive signal of stability and growth potential.
  • Strengthens Shareholder Loyalty:
    Bonus shares reward the shareholders and help in building goodwill among the investors. This will translate into a stable shareholder base whereby investors feel valued more and are willing to stay with the company long-term. Thus, such reduction in volatility can take place in the stock's price.
  • Optimizes Capital Structure:
    Bonus issues can be utilised by companies to convert reserves or retained earnings into equity in order to make the balance sheet look more good. This step will optimise the capital structure in such a way that the equity portion rightly portrays the company's retained earnings, which might make the company look more attractive to investors and lenders.
  • Maintains Control:
    A bonus issue does not reduce the ownership percentage of existing shareholders, unlike the issuance of new shares to the public. This feature thus enables firms to raise their equity base without changing control dynamics, ensuring current shareholders maintain their proportional stake in the company, while benefiting from the increased equity.

Advantages of Bonus Issue of Shares

  • Increased Shareholding:
    Bonus issues allow the shareholders to get more shares without cost, thus increasing their shareholding. This would bring up the perceived value of the investment, although it may be still the same in market value - at least for the initial outcome - a feeling of reward and satisfaction is imparted to the existing investors.
  • Improved Liquidity:
    A bonus issue can increase the liquidity of the stock by increasing the number of outstanding shares. Increasing its liquidity means the stock is turned over or traded more frequently and with narrower spreads, thus, it would be easier for investors to buy or sell a security, which will attract more participants into the market.
  • Market Accessibility:
    A bonus issue generally reduces the share price, thereby making the stock more attractive and affordable for smaller investors. This can further facilitate wider accessibility to attract more retail investors, higher trading volumes, and thereby a better market performance of the stock.
  • Positive Market Signal:
    The issue of bonus shares is very often perceived as a signal of a company's strong financial health and its confidence in future profitability. This good signal improves investor sentiment, which may result in higher demand for the stock, contributing to a higher share price over time.
  • Non-Dilutive:
    A bonus issue does not dilute the ownership percentage of existing shareholders since the new lot of shares is distributed proportionally. This warrants that shareholders remain in control and retain influence in the company while reaping the benefit of an increase in the number of shares, hence, it is a shareholder-friendly corporate action.

Disadvantages of Bonus Issue

  • No Cash Benefit:
    A bonus issue does not immediately give any cash to shareholders. Whereas the investors will be issued additional shares, there is no cash benefit accruing to them directly, which could be less attractive for those seeking income from investments, especially in times of financial distress.
  • Reduced Share Price:
    If the share price goes down after a bonus issue, this is due to the enhancement in the number of shares issued. This readjustment lowers the stock during the initial stages. This can bring about short-term volatilities or mislead investors into thinking that the value of the stocks has eroded.
  • Potential for Misinterpretation:
    Investors may also misinterpret it to mean some problem inherent in the financial position or as a certain replacement for dividend payment. It may influence the market sentiment negatively in case the investors perceive bonus issue to mask their financial distress instead of a sign of growth.
  • Dilution of Earnings Per Share:
    Although the percentages of ownership remain the same, earnings per share may become diluted because total earnings for the company must be spread over a larger number of shares. This reduced EPS could have an impact on financial ratios and investor's perception about profitability of the company.
  • Increased Administrative Costs:
    A bonus issue may therefore require additional administrative costs to update shareholder records and the re-issue of new share certificates. While normally affordable, such costs may be a stretch for smaller companies and may be regarded as diversion from more strategic initiatives.

Conclusion

A bonus issue is an instrumental approach to rewarding the shareholders, enhancing liquidity and hinting at the financial health of the firm. It simply provides companies with the opportunity to make their stock more affordable and attract a bigger demographic of investors by giving them more shares without losing any money. While there are certain advantages like more shareholding and marketability of the share, there also come the probable disadvantages like a fall in share price and reduced earnings per share. The result, when done properly, is that the bonus issue strengthens investor confidence and assists in underpinning the growth objectives of the company when executed in concert with the overall financial strategy and prevailing market conditions.

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FAQs

A bonus issue, also known as a scrip or capitalization issue, represents an additional amount of shares offered by the company to the existing shareholders free of cost against their present holdings. It is simply capitalised by converting the company's reserves or retained earnings into an increased number of outstanding shares without any change in the overall market capitalization.

After a bonus issue, the share price normally drops by an amount equivalent to the increase in the total amount of shares. This indicates that though the shareholder now has more shares, the value of his total market holding does not immediately increase.

No, a bonus issue does not provide the shareholders with any cash. A bonus issue increases the number of shares that the shareholders hold without any extra cost. The value of their investment remains unchanged, though they benefit from holding more shares.

The bonus issue will dilute the per-share earnings since the total earnings of the company have to be apportioned over increased shares. This may reduce the EPS, accordingly influencing financial ratios and perhaps investors' perception of profitability.

Yes, there could be some administrative costs associated with a bonus issue, like maintaining a shareholder record or even new share certificates, but generally the costs will be very minimal. These can be quite a headache for small companies and may be factored into the overall financial administration.

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