How rewarding are bonus issues?

There was a time, especially in the 1980s, when shareholders used to go crazy over issue of bonus shares. That craze died down as shareholders became more informed and market savvy. But there are still many investors who are gung-ho about bonus issues because they think they get bonus shares free of cost. So, let us take a hypothetical example to find out the facts.

Suppose, Company Zdeclares issue of bonus shares in the ratio of 1:1 and Mr A buys 100 shares of Company Z at the pre-bonus price of Rs 200 per share. So, A’s total investment in the stock of Company Z is Rs 20,000. After the bonus shares are issued by the company, Mr A’s total shareholding goes up to 200 shares, but the market price of the stock gets adjusted from Rs 200 to Rs 100 in line with the two-fold increase in share capital. Now, Rs 100 is the ex-bonus price of the stock,so effectively the total value of Mr A’s holding of Company Z’s shares has remained the same, that is, Rs 20,000 (200 shares x Rs 100). Therefore, Mr A has neither made any loss nor any profit on the shares of Company Z. Of course, after the bonus issue, the price of Company Z’s stock may move up or down, depending on the market condition and the financial performance of the company and Mr A may see the value of his shareholding increase or decrease.

The issue of bonus shares may also impact the dividend pay-out of Company Z and the dividend yield of an investor’s shareholding. Suppose, Company Z was paying dividend of 20% on the face value of shares for the past five years before the issue of bonus shares. The bonus issue depletes the reserves and surpluses of the company and, therefore, if the company reduces the dividend from 20% to 10% on the increased capital, the amount of dividend in the hands of the shareholders will remain the same. However, if Company Z declares a dividend of 15% post the bonus issue, the investors will stand to gain as they would get an increase of 50% in the dividend amount, whereas if the company declares a dividend of 8%, they would be getting 20% less dividend.

Therefore, depending on the movement of the stock price post the bonus issue and the rate of dividend declared by the company on the increased capital, we can determine whether or not the bonus issue was profitable for the investors. But, generally speaking, since only profitable companies go for bonus issue, one can say that such bonus candidates may prove to be profitable investments in the long run, if not in the short term.