Are bonus shares good for investors ?

Bonus shares for Investors

You might have heard companies announcing bonus issues for their shareholders. So what does it exactly mean ? Companies give away bonus shares to existing shareholders in proportion to the number of shares they hold. Now these bonus issues are generally announced in a specified ratio like 1:1, 2:1,1:4, etc. A 1:1 bonus issue means that shareholder receives one share for every share he/she holds without any extra payment. So if someone holds 10 shares of the company, he gets 10 more. Similarly for a 2:1 bonus, the shareholder gets twice the number of shares he already hold. So for 10 shares, the shareholder will get 20 more shares. Free shares !! Sounds tempting right? Here comes the catch. Though you get extra shares, but the share price of the company usually gets adjusted according to the bonus ratio. For example, if a share before the 1:1 bonus was trading at 1000 Rs, the post bonus price will be 500 Rs. But, since the number of shares have doubled and the price is halved, the total value of your investment doesn’t change exactly after the bonus. Then, what’s the point of doing this ?

 

Why do companies give bonus shares ?

Companies issue bonus shares to shareholders in lieu of paying a cash dividend. The company might want to use the cash to invest in high growth projects which will further boost their profits. Hence, it might chose to give bonus shares instead of dividend to gratify the shareholders. Some companies also share bonus issues when the stock price is high for retail investors. Bonus issues reduce the price of the stock and encourage retail investors’ participation.

 

What is in it for the investors ?

Companies issuing bonus shares is generally viewed as a positive step. The reason is that the company is conserving cash and reallocating it to high growth projects which will further increase companies profits and share price. So, though the investors don’t get any immediate gains. But over the long term, they get better returns from the business growth. Also, when in future the company pays dividend the shareholder gets more dividend as he holds higher number of shares. But, all investors might not have a long term outlook. For them, it would have been better to get cash dividend instead of waiting for long term benefits. But, in most cases the share price of the companies issuing bonus shares rise fast in the span of 1-2 years. Below are some examples of stocks which gave good returns after 1 year of bonus issue: Bonus shares - Good performers  

Should one buy a company issuing bonus shares?

In most cases, bonus issues are positive for investors. But you should not buy a stock just because it is issuing bonus shares. One must go through other fundamental parameters and market sentiments as well before making a buy decision. If these parameters and market sentiments are not favorable, then the stock might not perform well even after bonus issue. Below are few examples: Bonus shares - Bad performers Finally, if the fundamentals and future growth story of the stock looks good, then buying it after bonus issue can help you get good returns. Happy investing !!

Disclaimer: I am not a SEBI registered analyst and not advising anyone to buy. The purpose of this article is to share my viewpoint about fundamentals and the future prospects of the company. So, please do not consider this as an investment tip. Talk to your financial advisor before taking any investing call.

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