November 27, 2024
6 mins read
When investing in stocks, you may come across terms like bonus issue and stock split. They may seem complicated at first, but they are actually simple concepts.
Both increase the total number of shares you own, yet the overall value of your investment remains unchanged. The main difference lies in how the company carries them out and the reasons behind them.
A bonus issue usually rewards shareholders, while a stock split improves liquidity and affordability. We will explain both in a clear, step-by-step manner, helping you understand their impact on your investments as a shareholder.
A bonus issue, or bonus shares, happens when a company rewards you with extra shares for free. The number of shares you own increases, but the price of each share decreases in the same proportion, so your total investment value stays unchanged.
Think of it like this: imagine you have one chocolate bar. The company cuts that bar into two smaller pieces and gives both to you. You now have more pieces, but the total chocolate remains the same. That’s exactly how a bonus issue works.
For example:
In a 2:1 bonus issue, you get two extra shares for every one share you already own.
If you had 10 shares, after the bonus, you’ll hold 30 shares.
However, the share price will drop proportionally so that your total investment remains the same.
The important thing to note is that companies issue bonus shares from their reserves or retained profits. Instead of paying out cash, they convert their saved earnings into shares and distribute them among shareholders.
A stock split happens when a company divides its existing shares into smaller parts. For example, in a 2:1 stock split, each share is split into two, doubling the number of shares. The face value reduces, but the company’s total market value stays the same.
The purpose of a stock split is to make shares cheaper and easier for small investors to buy. For example, if one share costs ₹1,000, after the split it becomes ₹500. Your ownership percentage does not change, but more investors can participate, increasing trading and activity in the market.
Because both things increase your number of shares, it can be easy to confuse the two. But there are very different ways in which they function, and there are very different implications for you. Let's take a look at the two side by side:
Aspect | Bonus Issue | Stock Split |
Definition | Free additional shares are issued to you based on what you already hold. | Existing shares are split into smaller units. |
How it Works | Uses company reserves or profits to create new shares. | Divides existing shares, reducing their face value. |
Share Price Impact | Price falls in proportion to the bonus ratio. | Price falls in proportion to the split ratio. |
Face Value | Remains the same. | Reduced proportionally. |
Market Capitalisation | No change. | No change. |
Impact on You | You get more shares, but your total value remains the same. | You also get more shares, with no change in total value. |
Extra shares are added to your account automatically. | Existing shares are split and updated in your account. | |
Long-Term Effect | Shows company’s financial health, builds investor trust. | Increases affordability and attracts more investors. |
Tax Implications | No immediate tax; tax only applies when you sell. | Same as bonus issue – tax applies only when you sell. |
So, while both actions look similar at first glance, they serve different purposes for the company.
When a company announces a bonus issue or a stock split, the announcement generally indicates a desire to reward stockholders, create liquidity, and strengthen its market position. Although a stock split and a bonus issue serve different objectives, both actions can be based on the company's financial position and business focus.
Generally speaking, bonus shares are issued as a gesture of appreciation for long-term loyal shareholders without having to pay out cash. A bonus issue will add to an investor's holdings while demonstrating evidence of the financial strength of the company and it's profitability.
Bonus issues can also enhance the company's image and help attract long-term involved investors. They also can help lower a company's stock price, which can enable the stock to look more affordable for retail buyers that may have limited funds to invest. Because no cash is leaving the business, profits from the issue can still be used for future growth objectives.
A stock split simply reduces the price of a company shares which could motivate more small investors to take action to buy the shares and create a humorous amount of trading. Expanding the investor base is another plus.
Plus, anyone that missions a share price while trading will in part prior to touching on the over-valuation perspective from $75 to $70 to $82 - not only are they shortening their investment horizon, they are dropping retail targeted perception.
Also, they simply would become more appealing for institutional investors - as they investors like a stock to be attractively priced based on limited impediments (both price and number of shares sold). That's a successful strategy to maintain existing demand and equivalent market interest.
Bonus issues and stock splits are both events of significance to an investor and should be understood. They might be confusing at first because they both seem to increase the number of shares you own staggeringly and proportionally diminish the price per share.
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A bonus issue provides additional shares to shareholders for free, while a stock split divides existing shares into smaller parts to increase affordability.
A bonus issue reduces the share price proportionally to the bonus ratio but increases the number of shares, leaving shareholder value unchanged.
In a stock split, the face value of shares decreases proportionally to the split ratio while maintaining the total value of holdings.
Yes, companies choose based on their goals. Bonus issues reward shareholders, while stock splits improve liquidity.
Bonus issues reward shareholders with free shares, while stock splits make stocks more affordable, increasing accessibility and liquidity.
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