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Difference Between Stock Split and Bonus

In the world of investing, terms like "stock split" and "bonus" are often mentioned, but what exactly do they mean? A stock split occurs when a company divides its existing equity shares into multiple equity shares, while a bonus refers to the issuance of additional shares to existing shareholders without any additional cost.

Understanding these terms is crucial for investors as they directly impact the value and accessibility of stocks in the market.

In this article, we'll explore the key differences between stock splits and bonuses, helping you make informed decisions in your investment journey.

What is a Stock Split?

A stock split is a corporate action where a company divides its existing equity shares into multiple equity shares. This means that each shareholder receives a specified number of additional shares for each share they currently hold, while the total value of their investment remains the same.

For example, in a 2-for-1 stock split, each shareholder would receive two shares for every share they own, effectively doubling the number of shares outstanding.

Stock splits are typically carried out to make shares more affordable to investors and increase liquidity in the market, although they do not change the overall market value of the company.

What Is a Bonus Share?

A bonus share is an additional share that a company gives to its current shareholders at no extra cost. The number of bonus shares a shareholder receives is based on their current shareholdings.

Bonus shares are a company's accumulated earnings that are converted into free shares instead of being distributed as dividends. Companies may give bonus shares when they are unable to pay a dividend to shareholders despite earning good profits.

Bonus shares are always announced in a specific ratio, which results in a decrease in the company's share price by the same ratio value. For example, if a company announces a 2:1 bonus, the shareholder will receive two shares for free for every one share.

Bonus Share vs Stock Split: Impact on Share price

A bonus issue and a stock split both increase the number of shares outstanding and decrease the market price of shares. The extent of impact depends on the ratio of the bonus or split.

Here's some more information about bonus issues and stock splits:

1. Bonus Shares

In a bonus issue, the share price is directly impacted by the number of shares issued. For instance, with a 5:1 bonus issue, shareholders receive an extra five shares for each existing share held.

For example:

Share price before the bonus issue: Rs. 500
Total number of shares held before the bonus issue: 100
After Bonus Issue:
After the bonus issue, the share price stands at Rs. 83.33, calculated as 500 divided by 6.
The additional number of shares allotted is 500
After the bonus issue, the total number of shares held amounts to 600, comprising 100 existing shares and an additional 500 shares.

However, the face value remains unchanged after a bonus issue

2. Stock Split

In a stock split, the quantity of shares issued has a direct impact on the share price.

For instance, suppose a company declares a 1:3 stock split, signifying that each existing share will be divided into three shares.

Before the split:

Share price: Rs. 500
Total shares held: 100
Face value per share: Rs. 20.

After Stock Split:

After a stock split, the share price adjusts to Rs. 166.66 (calculated as 500 divided by 3), and the total number of shares held increases to 300. Consequently, the face value of each share post-split is Rs. 6.66.

It's crucial to understand that the market capitalization remains unchanged both before and after a stock split. This means that the total value of a company's outstanding shares remains constant throughout the process. To calculate market capitalization, the formula is as follows:

Market Capitalization = Number of Outstanding Shares * Price per Share

Let's illustrate with an example: Imagine a company with a market capitalization of Rs 1,00,000 and 10,000 shares outstanding. Each share is valued at Rs 10. Now, if the company opts for a 1:2 stock split, every shareholder owning one share will receive two shares. As a result, the total number of shares doubles to 20,000, but the value per share decreases to Rs 5. Importantly, despite the change in share quantity and value, the overall market capitalization remains unchanged.

Pros and Cons of a Bonus Issue

Pros of Bonus Issue:

Enhanced liquidity: By increasing the quantity of shares outstanding, a bonus issue can improve the liquidity of the company's stock in the market.
Rewarding shareholders: A bonus issue is often seen as a gesture of goodwill towards existing shareholders, as it increases their ownership stake in the company without requiring them to invest additional funds.
Signal of confidence: Issuing bonus shares can signal to the market that the company is confident about its future prospects and has sufficient retained earnings to support the issuance.
Potential share price appreciation: While the issuance itself doesn't directly impact the company's fundamentals, it can lead to positive sentiment among investors, potentially driving up the share price in the short term.

Cons of Bonus Issue:

Dilution: While existing shareholders receive additional shares, their proportional ownership in the company decreases. This dilution may not be welcomed by some investors, especially if they are concerned about maintaining their ownership stake.
Tax implications: In India, a bonus issue is not subject to tax. However, when shareholders eventually sell their bonus shares, they may incur capital gains tax, depending on the prevailing tax laws at the time of sale.
Market perception: In some cases, a bonus issue may be perceived as a sign that the company lacks investment opportunities or is unable to distribute dividends. This perception could potentially have a negative impact on the company's stock price.
Resource allocation: The resources used for a bonus issue could have been allocated to other purposes such as expansion, research and development, or debt reduction. Shareholders may prefer these alternative uses of resources depending on their investment objectives.

Bonus Issue vs Stock Split

Here's a table highlighting the key differences between a bonus issue and a stock split:

Aspect	Bonus Issue	Stock Split
Definition	Issuance of additional shares to existing shareholders for free.	Division of existing shares into multiple shares, increasing the number of shares outstanding.
Purpose	Reward existing shareholders and increase liquidity.	Adjust the share price to make it more affordable and increase liquidity.
Shareholder Implication	Increases the number of shares held by shareholders.	Increases the number of shares held by shareholders.
Impact on Share Price	Typically, this leads to a decrease in share price due to dilution.	Typically, this leads to a decrease in share price to adjust for the increase in shares outstanding.
Impact on Market Capitalization	No change as it's just a redistribution of existing equity	No change as it's a mere division of shares, not altering company value.
Regulatory Requirements	Subject to regulatory approval and compliance.	Subject to regulatory approval and compliance.
Timing	Often used as a means to reward shareholders during profitability.	It Can be implemented at any time, often in response to share price fluctuations.
Face Value	Remains unaltered	Remains unaltered

Pros and Cons of Stock Split

Pros of Stock Split:

Increased Liquidity: Stock splits typically result in more shares outstanding, which can increase liquidity in the market. This could potentially attract more investors, including retail investors, as the shares become more affordable.
Perceived Lower Share Price: While the market capitalization remains the same, a lower share price after a split may attract investors who perceive the stock as being more affordable, even though the company's underlying value hasn't changed.
Psychological Effect: Stock splits often have a positive psychological impact on investors. They may interpret a split as a signal of confidence from the company's management in its future growth prospects.
Accessibility: Reduced stock prices enhance accessibility for a diverse investor pool, accommodating individuals with limited funds and potentially expanding the overall shareholder community.
Increased Trading Activity: Stock splits can lead to increased trading activity, which can benefit the company by improving market visibility and potentially reducing bid-ask spreads.

Cons of Stock Split:

No Fundamental Change: A stock split does not change the fundamental value of the company. While it may attract more investors due to a perceived lower share price, the underlying value remains the same.
Transaction Costs: While liquidity may increase, frequent stock splits can lead to higher transaction costs for investors who need to buy or sell more shares due to the increased number of outstanding shares.
Potential for Misinterpretation: Some investors may misinterpret a stock split as a signal of poor performance or desperation on the part of the company, especially if it follows a period of declining stock price.
Focus on Short-Termism: Stock splits may encourage short-term trading behaviour rather than long-term investment strategies, as some investors may view them as opportunities for quick gains rather than focusing on the company's fundamentals.

Conclusion

Understanding the difference between stock splits and bonuses is essential for your investment decisions. While both actions aim to make stocks more accessible, they have distinct impacts on shareholders and companies.

Remember, informed choices lead to better investing outcomes. If you're looking for a user-friendly trading platform to execute your investment strategies seamlessly, consider using Bigul Trading Platform. It provides a simple and efficient way to manage your investments and stay updated with market trends.

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