Bonus Issue of Shares Explained and How They Work

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A bonus issue is a stock dividend given by the company to its shareholders as a reward. Whereas regular dividends pay out cash, these allotments provide free shares instead. 

These are issued from the business’ reserves and handed out in correlation with the current holdings of the shareholders, typically in a 1:1, 2:1, or 3:1 ratio. The decrease in stock price that comes with this issuance should not be misconstrued as a slip or correction.

If the ratio is 2:1, existing shareholders will receive two extra shares for every share they own at no extra cost. So if a shareholder possesses 100 shares, 200 bonus shares will be granted. 

Subsequently, the total number of holdings would sum up to 300. When the added shares are issued, the shareholder’s ownership of total capital will rise, but the investment’s worth will stay unchanged.

To further clarify, let us take the example of a bonus issue with different ratios – 1:1, 3:1 and 5:1

Bonus Issue  No. of shares held before bonus Share price before Bonus issue Value of Investment No. of shares post Bonus Share price after Bonus issue Value of Investment
1:1 100 75 7,500 200 37.5 7,500
3:1 30 550 16,500 120 137.5 16,500
5:1 2000 15 30,000 12,000 2.5 16,500

As you can see, bonus issues increase the number of shares held, but the value of your investment is not affected. It remains constant before and after the bonus issue.

The bonus announcement date, ex-bonus date, and record date are akin to the dividend issue.

Companies issue bonus shares to incentivize retail investors, mainly when their share price is very high, making it hard for new buyers to enter the market. This increases the number of outstanding shares and decreases their respective value. An example can be seen above.

Think of this – when the share price of a stock is too high, not all retail participants can afford to buy or sell it. For instance, MRF Limited was priced at around Rs.90,000 per share. 

This means that a small investor with only Rs.25,000 has no chance to invest in this stock. Many retail investors spread their risk across multiple investments instead of sticking to one. To prevent the prohibitively high prices from limiting access to these stocks, companies often issue bonus shares which reduce the stock price without having any effect on other financial parameters.

In the end, MRF’s decision about share splitting is completely up to them. 

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