“The best things in life are free. The rest are too expensive”. This is what summarises the importance of Bonus shares. They are free. They are more. And with the intrinsic feature of compounding, a meagre holding of 10 shares or 100 shares can over time transform into massive holdings of lakhs and crores of shares. I am just talking about the absolute number of shares, which in terms of value, can grow multi-fold and generate exponential returns and slowly snowball into a massive fortune.
What is Bonus Share
Let us talk about bonus shares, that every company distribute at some time, considered often as a win-win situation where the investor profit from increased holdings and the company profit from the participation of more investors and traders.
Bonus Shares Definition
Let us first understand what bonus shares are:
- Bonus shares generally known as scrip dividends are company’s accumulated earnings which instead of being distributed to the existing shareholders in the form of cash dividends, are given out to the current shareholders in the form of additional shares, calculated based on shares owned by them, at no extra cost. However, bonus shares can be distributed only by a company which has accumulated retained earnings or large free reserves, i.e. reserves not to be utilised for any specific purpose and can be distributed as dividends.
- Bonus shares enjoy all the rights and privileges of the existing equity shares. The only difference between the existing equity shares and bonus shares is that equity shares are issued against the receipt of consideration (value) in cash and bonus shares are issued free of cost and hence the term bonus. Issue of Bonus Shares does not alter the shareholding pattern since the bonus shares are issued on a pro-rata basis.
You will often hear about record date and ex-date whenever a company announces issuing of bonus shares. So let us understand what record date and ex-date are:
What is Record Date?
- The Record Date is the predetermined cut-off date set by the company when the investor must hold or own shares in his Demat account in order to be eligible for the bonus shares. The record date is set so they can identify the eligible shareholders and distribute bonus shares.
- All the investors owning shares in their Demat account on the record date are eligible for the bonus shares announced by the company.
- The bonus shares are generally credited to the Demat account within a period of 15 days from the record date.
What is Ex-date?
- In India, delivery of the shares in the Demat account happens after T+2 days. So, in case you don’t hold any shares of the distributing company, you must buy the shares two days before the record date, in order to turn eligible for the acquisition of bonus shares.
- The Ex-date is one day before the record date. Hence, you become eligible for the distribution of bonus shares, if you buy the shares before the Ex-date, in case you have not invested any prior amount. Ex-date marks the cut-off date before which investor must purchase the shares in order to be eligible for the distribution of bonus shares in proportion to the number of shares purchased by the investor before the said date.
- However, if you buy the stock for the first time on the ex-date, the shares will be credited to your Demat account after the record date, following T+2 settlement date, making you ineligible for any bonus shares. In such a case, the person who has sold the shares will be eligible for the bonus shares.
- Conversely, if you want to liquidate your positions in the related security and still be eligible for the bonus shares, you need to hang on to the shares until the ex-date.
Calculation Of Bonus shares
- The bonus shares are issued to the existing shareholders in proportion to the invested amount. E.g. bonus shares to be distributed in the ratio 2:3 means you get two additional shares for every three shares you hold in the company. So if you own 3000 shares of a particular company, you will receive 2000 additional shares at no cost.
Reasons for issuing Bonus shares
- Bonus shares are issued to the shareholder when the company is striving to reward the shareholders for placing trust in the management and fundamentals of the company but due to the paucity of funds unable to provide cash dividends.
- Bonus shares are also issued by the company when the company had an exemplary quarter but due to shortage of cash unable to distribute the gains, despite earning huge profits. In such a case, the company will distribute the earnings in the form of bonus shares by draining the profits, instead of paying dividends.
- Bonus shares are also issued by the company to restructure the reserves. Hence, it may deplete the reserves and increase its equity base. As issuing bonus shares to the existing shareholders are given from the profits or reserves of the company, issuing of bonus shares is also known as capitalisation of reserves.
- Companies low on cash may distribute bonus shares as a method of providing a steady flow of income to the shareholders, and maintain the established record of delivering returns to the investors.
- Also, the aim of bonus share mostly is to encourage and increase participation of retail investors as the share price decreases considerably in proportion to the allotment, and due to greater number of outstanding shares, it also increases the liquidity in the market.
Let us understand how the price changes after the issuance of bonus shares, which is the main repercussion of issuing of bonus shares:
Change in the prices after issuance of Bonus shares
- The share prices fall considerably in proportion to the allotment of bonus shares. The equity share capital remains unchanged while the number of shares outstanding increases. If a company’s share price is trading at 100, and the number of shares outstanding is 10 lakh, so the equity share capital comes at 10 crores. In the event of distribution of bonus shares, e.g. in the ratio of 1:1, the equity share capital remains unchanged while the number of shares increases to 20 lakh as one share is allotted for every share the investor holds in the company. Hence, the price of the share decreases proportionately to accommodate the change.
- The impact of bonus shares on the market capitalisation is zero-sum, i.e. the market cap remains unchanged.
- Post Bonus Ex – Bonus Price = Original Price prior to bonus * Number of Shares post bonus / Number of shares pre bonus.
- In case of a bonus issue, the Company decides the book closure and record date to ascertain the eligible shareholders. The stock price prior to record date is termed as “Cum Bonus”, and the price after the record date is termed as “Ex Bonus”. After the bonus issue, theoretically, the stock price gets adjusted in the ratio of bonus shares to existing equity shares.
Types of Bonus shares:
There are broadly two types of bonus issues as follows:
- Fully paid Bonus shares
When bonus shares are distributed at no additional cost in the proportion of the investor’s holdings in the company, it is called Fully Paid Bonus Shares. Fully paid-up bonus shares can be issued from the following sources: Capital reserves, profit and loss account, security premium account, capital redemption reserves, etc. However, bonus shares cannot be issued out of a capital reserve or security premium not realised in cash such as capital reserve created by revaluation of assets
2. Partly paid-up bonus shares
Let us understand what is a partly paid share before we define partly-paid up bonus shares
A partly paid share is a share in a company which is only partially paid as compared to the par value, with the understanding that calls for more funds will be made by the company from time to time until the shares are fully paid, after which no further calls will be made. So, when the bonus is applied to convert partly paid shares into fully paid shares without calling the uncalled amount, through capitalisation of profit, it is called Partly Paid-up Bonus Shares. However, unlike fully-paid bonus share, partly paid-up bonus shares cannot be issued out of security premium account and capital redemption reserve account.
Legal Requirements for Bonus issues
So what are the legal requirements for Bonus issues:
Bonus Shares can be issued only after a period of 12 months from the issue of shares for consideration. It can be issued only out of free reserves, i.e. the reserves created out of profits realised in cash. It has to be issued as Fully Paid, and only 2 bonus issues can be made in a period of 5 years. The balance of reserves after the bonus issue should work out to be 40% of the post issue capital.
Advantages of Bonus Issues from the investor’s point of view
There are innumerable advantages of Bonus issues from the investor’s point of view. Let us touch a few of those advantages
- There are no tax implications on receipt of bonus shares for investors
- It is specifically beneficial for investors who are looking to make investments over a long-term horizon. It is advantageous for Investors who have invested their hard-earned money to earn exponential returns in the future and wanted to increase the investment in the same to amplify those returns
- Let us see how corporate actions majorly involving bonus issues can provide astronomical returns
|Year||Action||Number Of Shares||Face Value|
|1980||Initial Investment||100||Rs 100|
|1981||1:1 Bonus||200||Rs 100|
|1985||1:1 Bonus||400||Rs 100|
|1986||Stock split to FV Rs.10||4000||Rs 10|
|1987||1:1 Bonus||8000||Rs 10|
|1989||1:1 Bonus||16000||Rs 10|
|1992||1:1 Bonus||32000||Rs 10|
|1995||1:1 Bonus||64000||Rs 10|
|1997||2:1 Bonus||192000||Rs 10|
|1999||Stock split to FV Rs.2||960000||Rs 2|
|2004||2:1 Bonus||2880000||Rs 2|
|2005||1:1 Bonus||5760000||Rs 2|
|2010||2:3 Bonus||9600000||Rs 2|
|2017||1:1 Bonus||19200000||Rs 2|
|2019||1:3 Bonus||25600000||Rs 2|
An initial investment made of Rs 10,000 for purchasing 100 shares of Wipro in 1980 can turn into 2.56 crore shares which at the stock price of 274.20 can yield a tremendous return of almost 701.951 crores after deducting the meagre amount of Rs 10000. This is the power of bonus issues over the long-term.
- Issuing additional cash and directing it towards the business growth and development increases the investors’ belief in the operations and processes of the company.
- If the company pays dividend in the future, the investor is bound to receive more as a result of holding an increased number of shares due to bonus issues. On 14-01-2020, Wipro announced a dividend of Rs 1, hence you would have earned 2.56 crores only for holding the shares since 1980.
- Improved Liquidity in the stock since the number of shares outstanding and tradable in absolute quantity increases
- Reducing Entry barrier since the ex-bonus price is lower than earlier, and therefore shareholders unable to buy stock earlier will now be able to leading to the widening of the shareholder base of the company.
Disadvantages of Bonus issues
However there are also certain drawbacks of the issuance of bonus shares that the investors must be aware of:
- Bonus shares may not add any value from a shareholders perspective. If at all, it deteriorates the quality of shareholders due to increased activity and entry of weaker hands in the stock. The rationale is the same as Mr Warren Buffett’s logic on Stock Split.
- The bonus shares don’t produce any additional wealth as the stock prices of the shares reduce in proportion to the allotment of bonus shares. Hence, the market capitalization remains unchanged and the same as before, keeping the wealth of the existing shareholders intact
- Also, the shareholders will be disappointed at the possibility of a truncated rate of dividends as the issue of bonus shares may not necessarily increase earnings. However, the earnings will be distributed among a much larger number of shares reducing the earnings per share and also in case of any future dividends, reducing the dividends per share.
- An investor may require liquidity to fulfil their financial obligations or meet their financial goals. They may expect liquidity in the form of cash dividends, and the receipt of bonus shares may just put their obligations and goals in jeopardy. The investor can surely meet these liquidity objectives by selling the bonus shares in the open market, but this would reduce their stake in the company proportionately.
- Investors must be careful of tax implications in case of selling bonus shares. In the above example of ITC, if you had sold bonus shares immediately ex-bonus, a tax liability of 15% would arise on the sale proceeds from bonus shares sold, and this tax liability could be much higher than the actual gain in the shares.
- Also, to avoid the risk of an auction, shares must be sold only after they are actually credited in your account. With SAMCO, this risk is avoided, since you can sell shares for delivery in CNC productonly after the actual availability of shares in your Demat account/trading account.
Risk of Auction of bonus shares sold without actual receipt of shares in Demat Account
Unlike stock splits where the shares with new face value are credited immediately, in case of a bonus issue of shares, the bonus shares are credited in your trading account/Demat account after a few days (usually 15 days) and not immediately after the ex-bonus date. Investors cannot also sell theses shares else would carry a risk of the auction due to default of payment in obligation of shares.
Caution – Ensure charts have been adjusted in case of Bonus Shares while conducting Technical Analysis of Chart patterns
Chart not adjusted for Bonus Shares – ITC Stock Chart – 1 Year Ending September 2016
Chart adjusted for Bonus Shares – ITC Stock Chart – 1 Year Ending September 2016
Above, we have 2 charts of the same stock ITC in the same 1 year period ending September 2016. The stock of ITC Limited went Ex Split on 01-07-2016 with a bonus issue of 1 bonus share allotted for every 2 shares held. Accordingly the price was adjusted and quoted from 360 odd levels (pre bonus) to 240 levels (post bonus). As you can see in the first chart, the prices have not been adjusted for the bonus in the charts and therefore we can see a huge gap in the charts whereas in the second chart, the price has been adjusted for the bonus issue in the charts and therefore we see no anomaly in prices and see a normal price pattern. If any trader was to apply any technical analysis methods such as moving averages, RSI, bollinger bands, etc in the first chart, the results would be absurd and would lead to incorrect conclusions.
Hence, it is very important that traders ensure that the charts have been adjusted for bonus before applying any technical analysis studies. The adjustment in charts needs to be done in both price and volume before analysis.
Tax Implication of Bonus Shares
Under the Indian Income Tax Act, the cost of the bonus shares is considered as zero. This means that when bonus shares are sold, the entire selling price is considered as capital gains. Whether it is considered as short term capital gains or long term capital gains shall depend on the tenure for which the Bonus shares have been held.
If bonus shares are held for more than 12 months from the date of being credited in the demat account, in that case, they shall be considered as held for long term and the capital gains would be Long term capital gains and hence exempt from taxation. If bonus shares are held for less than 12 months from the date of being credited in the demat account, in that case, they shall be considered as held for short term and the capital gains would be Short term capital gains and hence 15% STCG tax would be applicable.
There is no such tax implication in case of stock splits.
Upcoming bonus shares in 2020
There are some upcoming bonus shares in 2020 to keep an eye on. If you are not holding these shares, you can still be eligible for the bonus issues if you purchase its shares before the ex-date as discussed above. Let us see the upcoming bonus shares in 2020 that you can still benefit from, effective from 2nd September 2020
|Company Name||Proportion||Record Date||Ex-Bonus Date|
|Anuh Pharma||1:1||21st Sept 2020||18th Sept 2020|
|Banka Bioloo||3:2||9th Sept 2020||8th Sept 2020|
|Polyspin Exports||1:4||8th Sept 2020||7th Sept 2020|
|Rajnandini Metal||1:1||4th Sept 2020||3rd Sept 2020|
|Aaron Industries||10:11||4th Sept 2020||3rd Sept 2020|
- Bonus shares are additional shares provided at free of cost.
- Record date is the cut-off date by which the investor must hold shares to be eligible for bonus shares.
- Ex-date is the cut-off by which an investor must purchase shares for the shares to be deposited on the record date
- Reason for issuing bonus shares can range from providing dividends to the shareholder in the form of stock due shortage of cash to increasing retail investors’ participation, and expand the equity base.
- Advantages of Bonus shares:
- No Tax Implication on purchase of bonus shares
- Beneficial for investors looking for long-term investments
- Increased confidence in the operations of the company
- More dividends if the company decides to pay in the future
- Increased Liquidity
- Reduced Entry barriers for new investors
Invest in stocks with a long-term perspective, with expected bonus shares issuance or with an extensive history of issuing of bonus shares by downloading SAMCO’s Stocknote App or its sophisticated trader platform SAMCO Trader. Distribution of bonus shares may have certain drawbacks, but the benefits outweigh the shortcomings. And if you’re a long-term investor, then bonus shares are unequivocally valuable as seen from the Wipro example.
Our Stock Note App or the online trading platform SAMCO Trader will not only give you a flurry of recommendations of investing in companies with expected bonus shares in 2021, and the remainder of 2020 but also keep you regularly updated with news of announcements, record dates, ex-dates and proportion of bonus shares to be issued by different companies.