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On hearing the bonus shares name, we think that the company is giving free extra shares to the shareholders, but does this happen?
Definition
Bonus shares are the company’s free shares to its existing shareholders; it is beneficial at the time of dividend payout. When the company issues bonus shares, the shareholders get new free extra shares, and the share price decreases.
Explanation with examples
E.g., suppose there is a company called ABC whose share price is currently trading at Rs 1000. Now the company issues a 1:1 bonus share; this means that the company gives a free extra share to the shareholders in exchange for one share.
Let’s assume you have 100 shares of ABC.
| Before Bonus | After Bonus |
| Number of shares= 100 | Number of shares= 200 |
| Current Market Price= Rs 1000 | Current Market Price= Rs 500 |
| Total investment value= Rs 1000 x 100 shares= Rs 1,00,000 | Total investment value= Rs 1000 x 100 shares= Rs 1,00,000 |
Even after the issue of bonus shares, your investment value is also Rs 100000. So you must be wondering what the bonus like in this is.
Let’s understand it. Assuming the face value of shares of ABC is Rs 10, the company’s share price decreases in that proportion after issuing bonus shares, but the face value remains the same. Suppose the company ABC declares a 200% dividend, and the dividend is given on the face value.
Therefore,
Dividend= 200% of FV
=200% of 10
=Rs 20 per share.
Total dividend before bonus= Rs 20 x 100 shares= Rs 2000 and
Total dividend after bonus= Rs 20 x 200 shares= Rs 4000.
After the issue of bonus shares, you are getting more dividends. But this is possible only when the company will declare the same dividend even after the issue of bonus shares. Giving dividend is not compulsory for the company. Even if a company is giving regular dividends, there is no guarantee that the company will also give regular dividends.
Let us take another example of Infosys, which has a good track record of giving bonuses. The company shares were listed on the stock exchange in June 1993 at Rs 145 against the issue price of Rs 95 with a face value of Rs 10. Since then, the company has issued a bonus eight times. Let us try to understand it through a table; if someone buys 10 shares of Infosys with an initial investment of Rs 950 (Rs 95 x 10 shares) or Rs 1450 (Rs 145 x 10 shares) at that time, then how many shares would he have.
| Announcement Date | Bonus Ratio | Number of shares |
| 30 Jun 1994 | 1:1 | 10 + 10 = 20 |
| 18 Jun 1997 | 1:1 | 20 + 20 = 40 |
| 25 Jan 1999 | 1:1 | 40 + 40 = 80 |
| 13 Apr 2004 | 3:1 | 240 + 80 = 320 |
| 14 Apr 2006 | 1:1 | 320 + 320 = 640 |
| 10 Oct 2014 | 1:1 | 640 + 640 = 1280 |
| 24 Apr 2015 | 1:1 | 1280 + 1280 = 2560 |
| 13 Jul 2018 | 1:1 | 2560 + 2560 = 5120 |
If you had kept those 10 shares so far, it would have been 5120 shares. Now Infosys’s current market price is Rs 1067, so your total investment would be Rs Rs 1067 x 5120 shares = Rs 54,63,040. Apart from that, you also get the benefit of stock split and dividends. Infosys has so far given dividends 43 times and has split the stock once.
There are certain parameters from which we will know the probability of giving bonus shares by the company.
(1) Profitability. We have to check the company’s net profit for the last 4-5 years. If the company is earning a continuous profit, then it is good for the shareholders. It might distribute the profits in the form of bonus shares or dividends between the shareholders. When the company’s profit increases, then its reserves also increases.
(2) Reserves and Surplus. The company can utilize the reserves and surplus for various purposes like giving dividends, issuing bonus shares, buying back shares, or using it for expansion. If the company is not giving profits to the shareholders and not doing any corporate action, we should determine the company’s thought process behind this.
(3) Company’s thought process. The company may be thinking that it can grow money at a higher rate than the shareholders. Instead of paying the money as dividends, the company may expand its business and operations with that money. It will further benefit the shareholders in the long run, and the share price will increase. So this could be a thought process.
Big companies like Google, Microsoft, Berkshire Hathaway, etc. hardly have given any dividends or bonus shares to their shareholders. So instead of giving dividends or bonus shares, they utilize the money for expansion. So we have to find out whether the company thought process allows it to give us dividends, bonus shares or not. There is a probability that the company can come up with a buyback. So how do you check what is the company thought process. For this, we have to check the company’s history.
(4) Past History. We have to check whether the company has given any bonus in the past or not. If the company has not given any bonus until now, then giving a bonus in the future is less.
We have to keep in mind these parameters when we choose a company to get bonus shares.
| Bonus shares | Stock split |
| 1. The face value remains the same, and the company issues new extra shares to its existing shareholders. | 1. The face value of the existing shares is split, and the number of shares will increase proportionately. |
| 2. More benefitted during dividend payout as the dividend is paid on the basis of face value. | 2. Less benefitted during dividend payout as the face value is split. |
Also Read: Stock split: Definition and Objectives