Does Bonus Share Reduce Share Price: Bonus shares are one of the most creative ways that companies can reward their shareholders. There are times when the revenues and profits can be below expectations.
It could be due to a variety of reasons and as such, profits tend to fall. At such times, the board of directors has to come up with different ways to improve morale among investors.
Bonus shares are one of those creative rewards to shareholders. But how much do bonus shares actually benefit shareholders? Does bonus share reduce share price?
These are some of the interesting questions we’re going to answer in this article, starting with the meaning of bonus share.
What Is A Bonus Share?
A bonus share or bonus issue is when a company offers additional shares for free to existing shareholders of the company.
You might have come across news articles and headlines that read “EXY company announces bonus of 4:1, sets record date” Going by this example, it means that for every four equity shares held, the company will issue one bonus share.
Why Do Companies Issue Bonus Share?
Companies have various reasons to issue bonus shares to investors. In the recent past, several notable companies have issued bonus shares. One of the reasons for this is to improve retail investor participation, as the shares become affordable.
Another reason is bonus issues are an alternative to dividends. When the company is running low on funds to issue dividends, they tend to reward shareholders by issuing bonus shares.
These bonuses are usually issued from the company’s reserves. These reserves are basically the company’s net profits that have been accumulated over time, consistently in certain percentages.
Issuing bonus shares is also seen as a company having strong financials. It boosts the company’s reputation among existing shareholders and potential investors. This is especially true as the bonus shares are given using the reserves of the company.
Does Bonus Share Reduce Share Price?
To put it simply, yes, bonus shares do reduce the share price. The purpose of issuing bonus shares is to improve investor morale, both among shareholders and the investing community. The company does this by giving shares out of its own reserves.
Bonus shares increase the number of outstanding shares in circulation, but they don’t change the market capitalization of the company. In terms of liquidity, it is an excellent move by the management of the company.
Remember that bonus shares are the free shares given to their existing shareholders. They are not required to pay any extra money for these shares.
While the number of shares increases, it is done so proportionately. This means that every investor is given extra shares in equal proportion in ratios like 1:2, 1:3, etc.
Take the following example:
Mr. Z owns 10 shares of Tata Steel at a price of ₹100 each. Tata Steel has announced a bonus issue in the ratio of 2:1. This means that Mr.Z will receive 2 shares of Tata Steel for every share held on the ex-date/record date.
Going by the bonus ratio, Mr. Z will have 30 shares of Tata Steel after the bonus issue. This includes the 10 shares he previously held, along with the 20 additional shares received via bonus issue.
After this bonus issue, the share price will drop to ₹33.3, but the value of the shares held by Mr. Z will not fall. Here’s why.
Before the bonus: 10 shares x ₹100 per share = ₹1,000
After the bonus: 30 shares x ₹33.33 per share = ₹1,000
Why Does The Stock Price Fall After Bonus Issue?
Usually, when companies issue bonus shares, there is a fall in share price. This is because there is a fall in the company reserves after the bonus issue, and the overall share capital increases after the bonus issue.
Due to the increased number of shares, the book value of the shares fall.
Bonus shares are an interesting part of the stock market. It keeps investors interested in participating actively, while also keeping the company morale high. We hope our article on Does Bonus Share Reduce Share Price has provided valuable insights.
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