Stock Market News : As an investor or someone interested in the equity market, you may have come across the term “bonus issue” of shares. A bonus issue occurs when a company listed on a stock exchange decides to distribute free additional shares to its existing shareholders. This practice is relatively common among companies looking to reward their shareholders and enhance their market image.
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What is a Bonus Issue?
A bonus issue is a corporate action where a company offers additional shares to its existing shareholders without any additional cost. The distribution is based on the number of shares that a shareholder already owns. For example, if a company declares a 1:2 bonus issue, it means that for every two shares a shareholder owns, they will receive one additional share for free.
The Decision-Making Process
The decision to issue bonus shares is made by the company’s board of directors. The board discusses and finalizes the number of shares to be allocated to shareholders. This involves determining the ratio of the bonus issue, such as 1:1, 1:2, or any other ratio deemed appropriate. The company decides the number of bonus shares to be allotted to each individual investor based on the shares they hold over a specific period, rewarding them accordingly.
Purpose of a Bonus Issue
The primary purpose of a bonus issue is to reward existing shareholders and attract further investment. When a company issues bonus shares, it signals to the market that it is in a strong financial position, as the bonus shares are usually funded from the company’s profits or reserves. This enhances the company’s market image and can make its shares more attractive to retail investors.
One important aspect of a bonus issue is its impact on the company’s financial structure. While a bonus issue increases a company’s share capital, it does not affect its market capitalisation. Market capitalisation is the total value of a company’s outstanding shares, calculated by multiplying the current stock price by the total number of shares. On the other hand, share capital refers to the amount of money a company raises by issuing shares.
Funding the Bonus Issue
A bonus issue is typically funded by the company’s retained earnings, which are accumulated profits from previous years. These profits are reflected in the company’s annual or quarterly financial results. Alternatively, a company may use its share reserves to fund the bonus issue. By issuing bonus shares, a company essentially capitalizes a portion of its profits or reserves, converting them into share capital.
The Benefits of a Bonus Issue
From an investor’s perspective, a bonus issue has several benefits. First, it increases the number of shares they own without any additional investment. This can potentially lead to higher dividends in the future, as dividends are usually paid on a per-share basis. Second, a bonus issue can improve the liquidity of the shares in the market, making it easier for investors to buy and sell shares.
For the company, a bonus issue can help in broadening its shareholder base. By issuing more shares, the company makes its stock more affordable to retail investors, which can increase demand for its shares. This can lead to a rise in the stock price, although the price per share typically adjusts downward to reflect the increased number of shares.
Potential Downsides of a Bonus Issue
While a bonus issue has its advantages, it also has some potential downsides. One of the main concerns is the opportunity cost involved. The funds used for issuing bonus shares could have been invested back into the business to finance growth, research and development, or other initiatives. Some investors and analysts view this as a missed opportunity for the company to enhance its operations or expand its market presence.
Additionally, although the number of shares increases, the value of the company does not change. This means that the price per share will generally decrease after a bonus issue, as the overall value of the company is now spread across a larger number of shares. For example, if a company declares a 1:1 bonus issue, the number of shares doubles, but the price per share is likely to be halved.
Tax Implications for Investors
For investors, receiving bonus shares is not a taxable event. However, when the bonus shares are sold, the investor is liable to pay capital gains tax on the sale. The capital gains tax is calculated based on the difference between the sale price of the shares and their acquisition cost. In the case of bonus shares, the acquisition cost is considered to be zero, which means the entire sale proceeds are treated as capital gains.
On the company’s end, the issuance of bonus shares is not considered a taxable event. The company is not required to pay any taxes on the bonus issue, as it is simply a reallocation of its profits or reserves into share capital.
Case Study: Reliance Industries Limited’s Bonus Issue
To better understand the concept of a bonus issue, let’s look at a real-world example. Reliance Industries Limited (RIL), one of India’s largest conglomerates, recently announced a potential bonus issue. RIL is a diversified company with interests in oil, telecommunications, retail, and various other sectors. It is also India’s largest company in terms of market capitalization.
At its 47th Annual General Meeting (AGM) held on August 29, RIL announced that its Board of Directors would meet on September 5 to discuss and decide on a bonus issue. The company is considering issuing bonus shares in a 1:1 ratio, meaning that for every share an investor holds, they would receive one additional share for free.
The Significance of RIL’s Bonus Issue
RIL’s announcement of a potential bonus issue is significant for several reasons. First, it reflects the company’s strong financial position, as it has the profits or reserves required to fund the bonus issue. Second, it signals the company’s intention to reward its shareholders and attract further investment. By issuing bonus shares, RIL is likely to make its stock more affordable to retail investors, which could increase demand for its shares.
Additionally, the timing of the bonus issue is noteworthy. RIL’s decision to consider a bonus issue comes at a time when the company is undergoing significant expansion in various sectors, including telecommunications and retail. The bonus issue could be seen as a way to capitalize on the company’s growth and attract more investors.
Conclusion
In summary, a bonus issue is a corporate action that involves the distribution of additional shares to existing shareholders at no extra cost. It is a way for companies to reward their shareholders and enhance their market image. While a bonus issue increases the company’s share capital, it does not affect its market capitalization. For investors, receiving bonus shares is beneficial as it increases the number of shares they own, although they may be liable to pay capital gains tax when they sell the shares. However, companies must carefully consider the opportunity cost of issuing bonus shares, as the funds used could potentially be invested back into the business.