Making money in the stock market is not an easy task. It requires right set of knowledge, information and skills to earn handsome returns. Furthermore, it is essential to know the meaning of right terms. The investors may come across different terms each day in relation to their holdings in the portfolio. In fact, one term is bonus shares. In this article, we shall understand about bonus shares.
Meaning of Bonus Shares
Bonus shares mean additional shares. In fact, the company issues these shares to the shareholders without incurring any additional cost. Moreover, bonus shares are given to the current shareholders based on the number of the shares held by them. Furthermore, the bonus shares are given out of the accumulated earnings of the company. To put it another way, the company utilizes it’s accumulated earnings to issue bonus shares instead of distributing it as dividends.
The important question that arises is why companies issue bonus share. Let us understand it in this segment.
Reason for Issuing Bonus Share
When the company issues bonus share the overall capital of the company remains the same. However, with the issue of bonus share, the price of shares decreases as the number of shares increases. Furthermore, with the decrease in the price of shares, it becomes easier for the retail investor to invest in the company if the price is low. Therefore, bonus share increase retail participation and equity base of the company.
Let us now see an example of how bonus share are issued to existing shareholders.
Example of Issuing Bonus Shares:
Suppose Ram holds 100 shares of Reliance Industries at Rs.1600. Now the company decides to issue bonus share to its existing shareholders. Furthermore, the company declares 2:1 bonus. To put it another way, the shareholders shall get 2 shares of Reliance Industries for every one share of the company. Therefore, the shareholding of Ram shall increase from 100 shares to 200 shares. Moreover, the price of shares shall fall from Rs. 1600 to Rs. 800.
Let us now look at the advantages and disadvantages of issuing bonus share.
Advantages of Issuing Bonus Shares
- Issuing bonus share increases the issued share capital of the company. This makes the company look much bigger than it is in reality.
- Issuing bonus share make the stocks more affordable for the retail investors because of a decrease in share price. Therefore, the participation of retail investors increases.
Disadvantages of Issuing Bonus Shares
- Issuing of bonus share can result in a decline of dividend payment per share.
- Shareholders sell their stake in the company after they receive the bonus shares to meet their liquidity needs. Consequently, their stake in the company decreases.
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