Bonus Shares & Impact of Bonus Shares for Investor

Continuing the discussion from Investing Basics - Feel free to ask the most basic questions, here:

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It is best to think of things in terms of 1. Owning a percentage of the company and 2. The full market cap of the company.
So if you own 100 shares and there are total 100,000 shares then you own 1/1000 of the company, i.e. 0.1%
Since the bonus shares do not change your ownership fraction, you have neither gained nor lost anything by this action.
Once you own a fraction of a company, you gain when the market cap of the company rises and you lose when the market cap of the company falls.
Or you can think of it in this way. You have one slice of a pizza which has total 8 slices. If all slices are cut in two, do you now have more pizza or less pizza?

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Yes, one should think in terms of %age of company owned. However bonus shares do help in some cases for existing investor in cases of shares which are of high prices (say where the share price is more that 5000/- etc and it splits into 10 shares of 500/- each); as it many more investors/traders jump in (perception bias that share is no longer expensive) causing trading volumes to rise – which may possible cause price to jump up by 5 to 10% in short term and maybe more in long term.

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The replies mostly are pertinent to splitting of shares - where the face value of the shares is reduced and nothing changes other than number of shares traded. There is no change seen in balance sheet other than the mentioned face value of share. There is no money involved in split of shares and there wont be any impact on ratios like ROE.

But bonus shares will impact ROE if equity capital increases. does it mean issuing of bonus shares from balance sheet perspective is just moving money from reserves to equity capital? so the money from reserves is utilized for say capex but it will show as equity capital usage? how does bonus shares bode for future ROE? Does bonus share issuance lead to equity dilution?

Total Equity = Equity Share Capital + Reserves

ROE is calculated using Total Equity, so bonus wont effect ROE
EPS is calculated on total number of shares which is Equity Share Capital divided by face value. So bonus will impact EPS.

But since its a transfer from one line item to another, there is no impact on the business other than psychological illusion that the stock price looks ‘cheap’. Lot of people don’t buy page industries as it is ‘expensive’ at 15000. if they issue 10:1 split and 10:1 bonus they will think its cheap at 150

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Bonus share doesn’t change your % ownership of the business. This fact is used to argue that bonus shares don’t impact you in anyway. It doesn’t change anything fundamentally. In effect you should be indifferent whether bonus shares have been issued or not.

However there is another angle which I would like to explore and understand better with data.

  1. Bonus shares increases the no of shares outstanding, thus increasing the liquidity for these shares. Liquidity in turn will enable more buyers to buy the stock.
  2. Also it brings down the entry price for small investors. For example someone wanting to invest 10000 Rs in Page Industries cannot do that today. To talk about a US example, not many people will have 200000 USD kept aside to buy 1 Berkshire share. However if the same falls down to 20000 USD, logically many more would be tempted to own Berkshire shares.
  3. Ultimately all of us want to invest in shares which are undervalued at present and is likely to get overvalued in future or at least fairly valued. Given that psychology and emotions play such an important role in investing, what is likely to attract more investors and thus get overvalued? Something available for 15000 a piece or something available at 150 a piece. Many novice investors in market will actually have a tendency to buy more of 150 a piece than more of 15000 a piece

Based on points 1,2 and 3 above can it be assumed that bonus shares actually contribute to increasing prices by stimulating some demand hitherto excluded from market?

A contra view is that there is something called scarcity premium. Lower free float or higher per unit prices mean only so much is available. Which creates some sort of scarcity and actually helps maintain higher prices. If that scarcity vanishes, any premium related to such scarcity will actually lower the prices.

Of course both these views assume “all other factors remaining the same”. Does anyone have any data for and against these views or may be just a personal experience from owning shares where bonus was announced?

I am tilted in favour of “all other factors remaining the same” it is better to have bonus shares as over long term it will enable more buyers to buy the stock, make the ownership more broad based, reduce volatility and help in fair price discovery. I don’t have any data to back up this notion at present though.

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My answer may be obvious but let me write my first comment at valuepickr. Bonus share has some impact on wealth creation on short term. If there is a bonus declared, then the extra shares we get are considered as acquired now. So any sell to new shares within 1 year will result is short term tax gain which is different than split.

For ex. Suppose Ex bonus I have 100 shares. After 1:1 bonus my shares become 200. But selling of new 100 shares will result in short term tax gain if sold within a year as per the current tax rules.

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@ soodhakar , this rule looks very strange to me , This type of thing should result in extra volatility in share after the company announce bonus as people who are holding for steady move to higher lever but are holding only because they find this slow upmove to make more money for them due to tax free effect should look to exit now .

@Robin_5716, Yes I have experienced this one. As I am holding Tech Mahindra since satyam days. Recently they have split 1:1 and announce bonus 1:1. So the share price gone down from 2800 too 700 approx. Then share price gone down to 500 now. So anyone want to exit has to face the short term taxation also. So I have seen ex bonus there is some sell in some shares may be due to taxation.

@soodhakar superb u got a short term capital loss now , u can sell those bonus share and buy back them after few days and u will end up with short term capital loss which can be clubbed with your gain ?

nice arb opportunity you got here i think .

How capital loss? For income tax, cost of bonus shares is taken as nil. So the entire consideration recd will be a long or short term cap gain.

@bomi if taken as nil then any price will be profit ?

@Robin_5716 As per Bomi, There will be no capital loss. Half will incur long term capital gain and other half short term capital gain. The worst part is as the new share cost value is zero so the total sell value of new shares will incur short term capital gain @15%.

But there is another scenario If the original holding is less than 1 year of 100 shares and bonus is declared 1:1, then the if someone sell 100 shares then it will incur short term capital loss which can be clubbed with your other gains.

One query to seniors, If one person want to buy N shares of X price of a company which is declared bonus 1:1 on a future date, Then he can buy 2N shares before bonus which will be 4N Ex bonus. Then he sell 2N shares Ex bonus. Then his holding will be 2N shares and a short term capital loss of 2NX/2 = NX amount, which can be adjusted with any short term capital gains. The Catch is other 2N shares he has to hold till one year to avoid short term tax on whole sell value as the cost value is zero. Is it a good idea or I am wrong at any place.

Yes you are right. The technical term for this whole process is ‘Bonus Stripping’. Below is an old article from Business Standard. The article also cautions about a possible change in tax law effective from 1st April 2015 :flushed:

Thanks @manishkdwivedi. This is a good counter part for the short term capital loss to avoid tax. The same article says that the benefit may be cancelled for 5 crore or more as below.

Tax experts say if the General Anti Avoidance Rule comes into effect, the deadline for which is April 1, 2015, bonus strippers could be pulled up. The law says if any transactions does not have any commercial substance but results in lower tax, then the tax department can cancel the benefit and recalculate the tax. However, the threshold for this rule is tax benefit of Rs 5 crore or more.

I think we should ask some good CA for this or spend some time on google for this.

enquired with a tax inspector , one has to keep share for more than a year from the date of allotment else it will result in short term capital gain and gain will be price * quantity as buying price is nill .

But why share dont result in volatility before going X bonus . :confused:

I have a query here:
In case of Bonus issue say (2:1 i.e. for 2 shares you will get 1 share) where investor is holding an odd number of shares, how is the last 1 share accounted for.
e.g. if Investor has 25 shares, he will end up getting 12 shares after Bonus and his holding will become 37.
However, he would have got 12 shares if he was holding 24 originally. So the difference - 1 share - it goes where?
Assuming there will be thousands of shareholders like this, so this 1 share/investor can become significant when combined together.
Hope I made the question clear.

In such scenarios, company will buy the fractional shares and money will be credited in your bank account.

I have seen a similar pattern in some shares. Post bonus the share goes down (700 to 500 in ur case). Why would (existing) shareholders look to exit if they would incur STCG tax ? Can you elaborate more on this