Companies accumulate their profits as reserve funds instead of paying the shareholders as a dividend. When this accumulated reserve is converted into share-capital and allotted to shareholders, it is called bonus shares. Bonus shares are issued in proportion to the shares held by the shareholders. This way, the share capital of a company will increase resulting in a decrease in reserve funds. Share-holders get additional shares as compensation instead of dividend.

In case of a share split, of let us say, a share of Rs.10 into Re 2 face value, there will not be any increase or decrease in the company’s reserves. One share of Rs 10 share would now be converted into five Re 2 shares. When a company issue a 1:1 bonus, a shareholder with one share of Rs 10 face value will get another share of the same face value.

WHY ISSUE BONUS SHARES?

A larger number of shares in the market improve liquidity and help trade in large volumes. This is one of the reasons why the bonus is declared by companies.

A bonus issue reflects a company’s confidence in its ability to service a wider equity base. It is considered to be a good mechanism to signal the capacity of the company to deliver benefits to shareholders in the future, by way of a dividend increase.

Not every bonus issue can be considered to be a positive sign. It could be a ploy is used by the company to boost sentiment and hide poor performance.

A lower price also makes the stock seem more affordable to small retail investors, who might otherwise give it a miss at high price levels

What is the effect of the bonus issue on investors?

The bonus issue does not affect one's investments. After a bonus issue, the share price usually falls in proportion to the bonus issue, and so there will not be any change in the total value of shares. Sometimes a bonus issue is considered to be a positive signal from the company as this increases the demand for the shares thereby moving up the price. It could mean a substantial increase in the wealth of shareholder’s holdings in the long run.

Reasons for a stock split.

The main reason for the stock split is for infusing additional liquidity for the shares as it would become more affordable. It should be noted that the shares simply appear to be cheaper. An investor can buy more shares for the price of one.

HOW DOES IT AFFECT YOU?

It does not change the fundamentals of the company. The share capital and revenue remain the same, while the profit will also remain the same. As the number of issued shares has increased, the Earnings Per Share – EPS decrease by the same ratio.

If EPS before the split was Rs.10 per share for a share with a face value of Rs.10, then after a 10:1 split, the EPS will come down to Rs 1. But as one would be holding 10 shares instead of 1 now, the share of EPS will remain the same: Rs. 1 x 10 shares = Rs. 10.

If for example, the PE of a stock is 20, the price will go down from Rs. 200 (EPS of Rs. 10 x PE 20 = Rs. 200 per share) to Rs. 20 (EPS of Rs. 1 x PE 20 = Rs. 20 per share). But as the shareholder would be having 10 shares now, their actual holding will remain the same: Rs. 20 * 10 shares = Rs. 200. You can see that there is no change whatsoever except that the number of shares traded is more.

Why does the market react positively after the stock split?

The positive sentiment of the Stock market after a stock split is because it is considered to portray the confidence of the company and interprets the split as a positive signal of the company’s confidence in its future growth. After a stock split, there is an increase in the number of shares traded increasing liquidity of the stock.

As an investor one has a reason to celebrate a bonus issue. But it is not the case when the company splits the stock as it is a technical change in the face value of the stock. But it is good news to those who are planning to invest in the stock because it is affordable.