The word ‘bonus’ gives people a surreal level of happiness. Be it winning bonus points in a quiz competition or getting one month’s salary as a bonus during the Diwali festival. Similarly, companies in the stock market also issue bonus shares to collect some more funds. But, what are bonus shares and what ‘bonus’ does an investor get?
What are bonus shares?
Bonus shares are additional shares given to the existing shareholders without any additional cost. Firms follow the Indian retail shopper’s favourite scheme of ‘Buy One Get One free’ where a current shareholder will get free or additional shares based on the existing or earlier shares held in the company.
Why do companies issue bonus shares?
Bonus shares are issued by the companies when they are facing a financial crunch and are not able to pay dividends to their shareholders despite earning decent profits in a particular quarter. The profits earned are not sufficient to distribute as dividends. In such cases, these shares are issued in place of dividends.
Companies also issue bonus shares to capitalise on a part of the company’s retained earnings. Moreover, such shares are also issued to encourage retail participation and increase their equity base as an increase in the number of shares reduces the price allowing more investors to participate.
The bonus share distribution works in this way:
Suppose, an investor holds 300 shares in a company. The company declares a 4:1 bonus which means that now the investor, for every share bought, will get 4 additional free shares thereby, totalling its hold to be 1200 (300X4) shares.
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Receiving bonus shares increases the share of an investor in the company and bolsters trust as the cash will be used by the company for its growth.
Types of bonus shares
There are two types of bonus shares issued:
Fully paid:
Fully paid bonus shares are distributed to the investors with no additional cost in the proportion of the shares held in the company. These bonuses are issued from the following sources:
- Profit and Loss account
- Capital reserves
- Capital redemption reserves
- Security premium account
Partly-Paid:
Some shares in the company can be bought by an investor by not paying their full price which is called partially paid shares. The remaining amount is paid through instalment. But, when the partially paid shares are distributed as bonus shares, the partially paid shares of the investor are converted into fully paid shares. These shares are issued from the below sources:
- Investment allowance reserve
- General reserve
- Development rebate reserve
Who is eligible to purchase bonus shares?
Investors who own a company’s shares before the ex-date and record date become eligible to receive bonus shares from the company.
Here, the record date is the date when the issuing company fixes a particular date to check its records to identify shareholders of the company eligible for receiving bonus shares. Ex-date is the date just a day before the record date set by the company. In India, the delivery of shares into a Demat account takes place two days after the trading date.
Advantages to the investor for having bonus shares
- Investors need not pay any tax while receiving bonus shares from the company.
- Owning such shares is beneficial for long-term shareholders who want to double their investment.
- Receiving bonus shares increases the share of an investor in the company and bolsters trust as the cash will be used by the company for its growth. This speaks for the company’s commitment towards long-term growth and liquidity of stocks.
- If a company declares dividend, the bonus shareholders will receive a higher dividend due to a large number of shares held.
Disadvantages
There are no disadvantages of owning bonus shares but an investor should know that profits received will be the same after receiving bonus shares. The earning per share will fall since the number of shares will be increased.
