Part 32 - Understand Split vs Bonus Shares Explained in Depth
Part 32 - Understand Split vs Bonus Shares Explained in Depth
Split and Bonus Shares: Detailed Explanation with Examples
Split vs Bonus Shares Demystified: What Traders Need to Know
Split Shares (Stock Split) and Bonus Shares are corporate actions that companies undertake to adjust their share structure, often to make shares more accessible to investors or reward shareholders.
While both can increase the number of shares held by investors, their mechanisms, purposes, and impacts differ significantly.
Below is a detailed explanation of each, including examples.
Stock Split -
Definition -
A stock split is a corporate action where a company divides its existing shares into multiple shares to increase the number of shares outstanding.
The total value of the shares remains the same, but the price per share decreases proportionally, making the stock more affordable for retail investors.
Share Split (Stock Split) - What It Means
A stock split increases the number of shares in circulation by dividing existing shares into multiple new ones—without changing the total value of your investment.
Key Features
Purpose:
To reduce the share price to make it more attractive to smaller investors, improve liquidity, and potentially broaden the shareholder base.
No Change in Total Value:
The market capitalization (total value of all shares) remains unchanged because the split only redistributes the same value across more shares.
Types:
Forward Split:
Increases the number of shares (e.g., 2-for-1, 3-for-1).
Reverse Split:
Decreases the number of shares (e.g., 1-for-2), often used to increase share price to avoid delisting from stock exchanges.
Impact on Shareholders:
Shareholders receive more shares, but the value of their holdings remains the same. For example, in a 2-for-1 split, you get twice as many shares, but each share is worth half as much.
How It Works
The company announces a split ratio (e.g., 2-for-1, meaning 2 new shares for every 1 old share).
The share price is adjusted proportionally (e.g., if the price was $100, it becomes $50 in a 2-for-1 split).
The total number of shares outstanding increases, but the market capitalization remains the same.
The split does not affect the company’s financials or the shareholder’s ownership percentage.
Example of a Stock Split
Suppose you own 100 shares of XYZ Corp, and each share is priced at $200, making your total investment worth $20,000.
The company announces a 2-for-1 stock split.
Before Split:Shares owned: 100
Share price: $200
Total value: 100 × $200 = $20,000
After Split:Shares owned: 100 × 2 = 200
Share price: $200 ÷ 2 = $100
Total value: 200 × $100 = $20,000
Your ownership percentage in the company and the value of your investment remain unchanged, but you now hold more shares at a lower price per share.
This makes the stock more accessible to new investors, potentially increasing trading volume.
Advantages of Stock Split
Increased Liquidity: Lower share prices make it easier for more investors to buy, increasing trading activity.
Psychological Appeal:
Lower prices may attract retail investors who perceive the stock as "cheaper."
No Tax Implications:
Since the total value of holdings doesn’t change, stock splits are typically not taxable events.
Disadvantages of Stock Split
No Real Value Added: The intrinsic value of the investment remains the same.
Administrative Costs:
The company may incur costs for updating records and issuing new shares.
Perception Issues: In some cases, splits (especially reverse splits) may signal financial distress.
Real-World Example
In August 2020, Apple Inc. executed a 4-for-1 stock split.
Before the split, Apple’s share price was around $400.
After the split:Shareholders received 4 shares for every 1 share held.
The share price dropped to approximately $100.
The total value of an investor’s holdings remained the same, but the lower price made Apple shares more accessible to smaller investors.
Reverse Split examples -
Suzlon Energy Ltd.Industry: Renewable Energy
Reverse Split Details: In 2010, Suzlon Energy announced a 1:5 reverse stock split to boost its share price and avoid delisting from stock exchanges due to low trading prices during financial difficulties.
Yes Bank Ltd.Industry: Banking
Reverse Split Details: In 2020, Yes Bank implemented a 1:10 reverse stock split as part of its financial restructuring after a bailout by the Reserve Bank of India (RBI) and State Bank of India (SBI).
2. Bonus Shares -
DefinitionBonus shares are additional shares issued by a company to its existing shareholders at no cost, typically funded from the company’s accumulated profits or reserves.
Unlike a stock split, bonus shares increase the total number of shares outstanding without reducing the share price immediately, as they are essentially a distribution of profits in the form of shares.
Key Features
Purpose:
To reward shareholders, conserve cash (instead of paying dividends), and signal confidence in future earnings.
Source: Issued from free reserves, retained earnings, or other capital reserves.
No Change in Shareholder Wealth Initially:
The share price adjusts over time due to the increased number of shares, but the total value of holdings remains the same immediately after issuance.
Impact on Shareholders:
Shareholders receive additional shares proportional to their holdings, increasing the number of shares they own without additional investment.
How It Works
The company announces a bonus issue ratio (e.g., 1:1, meaning 1 bonus share for every share held).
The shares are issued from the company’s reserves, reducing the reserve account and increasing the share capital.
The share price typically adjusts downward after the ex-date (when the stock trades without the bonus entitlement) to reflect the increased number of shares.
Unlike dividends, bonus shares are not taxed immediately in most jurisdictions, as they are not cash payouts.
Example of Bonus Shares
Suppose you own 100 shares of ABC Ltd, and each share is priced at $50, making your total investment worth $5,000.
The company announces a 1:1 bonus issue (1 bonus share for every share held).Before Bonus Issue:Shares owned: 100
Share price: $50
Total value: 100 × $50 = $5,000
After Bonus Issue:Shares owned: 100 + 100 = 200
Share price: Adjusts to $25 (assuming market capitalization remains constant: $5,000 ÷ 200 shares)
Total value: 200 × $25 = $5,000
Your total investment value remains the same, but you now hold more shares.
The company’s reserves decrease by the value of the bonus shares issued.
Advantages of Bonus Shares
Rewards Shareholders:
Increases the number of shares without requiring additional investment.
Conserves Cash:
Allows the company to reward shareholders without paying cash dividends.
Signals Confidence:
Indicates the company has strong reserves and expects future growth.
Potential Tax Benefits:
In many jurisdictions, bonus shares are not taxed until sold, unlike cash dividends.
Disadvantages of Bonus Shares
Dilution of Earnings Per Share (EPS): More shares outstanding can reduce EPS, potentially affecting stock valuation.
No Immediate Cash Benefit:
Shareholders don’t receive cash, which may disappoint those seeking dividends.
Market Adjustment:
The share price adjusts downward, so the immediate financial impact is neutral.
Real-World Example
In 2017, Reliance Industries Limited (India) announced a 1:1 bonus issue.
For every share held, shareholders received one additional share.
If an investor held 100 shares priced at ₹900 each:Before: 100 shares × ₹900 = ₹90,000
After: 200 shares × ₹450 (adjusted price) = ₹90,000
The investor’s wealth remained the same, but they held more shares, and the stock became more affordable for new investors.
Example 2 Bonus Share -
Bajaj Finance – June 2024
Announced a 1:1 bonus issue and a 1:5 stock split simultaneously.
If you held 1 share, you received:
1 bonus share (1:1)
Then each of those 2 shares was split into 5, giving you 10 shares total.
Impact
Before: 1 share at ₹7,000
After: 10 shares at ₹700 each
Total value: ₹7,000 (unchanged)
Why Companies Use Stock Splits and Bonus Shares
Stock Splits: Often used by companies with high share prices (e.g., tech giants like Apple or Tesla) to make shares more accessible and increase trading volume.
They signal strong market confidence but don’t alter the company’s financial structure.
Bonus Shares:
Common in companies with large cash reserves (e.g., Indian firms like Reliance or Infosys), used to reward shareholders while retaining cash for reinvestment.
They signal optimism about future earnings.
Impact on Investors
Stock Splits:
Investors see no change in wealth but benefit from increased liquidity and potential price appreciation if demand rises due to affordability.
Bonus Shares:
Investors receive more shares, which may increase future dividend payouts (if the company pays dividends) but face a temporary price drop due to dilution.
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