What are Bonus Shares?

Do you want to know all about what bonus shares are? Bonus shares are one of the best stocks available to investors. A shareholder only needs to own shares in the company that is issuing bonus shares to the one eligible for bonus share offerings. 

This article explains what bonus shares are, who is eligible for them, their advantages and disadvantages, and how it works. Let's dive into the discussion below. 

What are bonus shares?

Even if a company is profitable, it may be unable to pay dividends on its profits. In this case, it may provide additional shares to existing shareholders. 

The bonus shares are distributed to shareholders based on the amount of stock they already own. Bonus shares are a way for companies to reward their shareholders when their cash flow has dried up, and their balance sheet does not have enough cash.

Companies can use bonus shares to convert their accumulated profits into stock capital. Giving out bonus shares keeps the company from having to pay dividends. It simply allows the company to keep more cash on hand. 

It simply lets the company understand that bonus shares do not bring or take money from the company. Only the share capital changes while the company's net asset base remains constant.

Why are bonus shares distributed? Major reasons to know

The following are a few of the reasons why bonus shares are distributed:

• They are distributed to lower the market price per share by distributing more shares.

• Bonus shares are distributed to make it convenient for investors to buy and sell stock. This increases the number of shares owned by individuals.

• Bonus shares are distributed to maintain the company's reputation in the eyes of investors. This increases the share capital base of the company.

• Distributing bonus shares demonstrates to investors that the company is doing well and enhances the company's image.

• When bonus shares are distributed, the chances of winning more money increase.

Types of bonus shares

Following are the basic types of bonus shares and how they work:

Fully paid bonus share

Fully paid bonus shares are distributed to shareholders in proportion to the number of shares they already own. 

A corporation can use funds from its security premium accounts, capital reserves, profit and loss accounts, capital redemption reserves, and other accounts to pay for fully paid bonus shares.

Partially paid bonus shares.

You are also not required to pay anything for partially paid bonus shares. A company will offer partially paid bonus shares to convert partially paid shares into fully paid shares. 

Partially paid shares are those for which the company would contact the customer to request the remaining funds.

Who is eligible for bonus shares?

Shareholders who own shares of the provider company before the record date and ex-date, which the company will announce, will now be eligible for bonus shares. 

The T+2 rolling system governs how shares are delivered on the Indian stock exchange. Thus, the record date is two days before the ex-date in this case. An investor must purchase shares before the ex-date to be counted as theirs.

The bonus shares are given a new ISIN after the shareholder has purchased the required shares (International Securities Identification Number). Within 15 days, the bonus shares will be part of the shareholder's account.

Advantages of bonus shares

The benefits of bonus shares are the same as those of regular shares. Let us take a look at the same thing:

Improves the company image

When bonus shares are distributed, the company's total share capital increases, this makes investors feel good about the company and improves its market reputation.

Free-of-cost bonus stocks

These shares are distributed for free to those who already have a stake in the company. 

They are derived from free reserves created when a company makes a profit. This increases shareholders' wealth and makes selling shares on the market easier.

Saves tax

Long-Term Capital Gain is tax-free up to a limit of Rs. 1, 00,000. This is how shareholders can avoid paying taxes by holding on to a share for more than a year.

There was no money spent

There is no need for a company to use its cash reserves to distribute bonus shares. They are instead distributed from the company's reserves and surplus. 

This reduces the company's debt while increasing its capital. As a result, they can put the entire money to good use by expanding their business.

What are the disadvantages of bonus shares for investors?

Bonus shares provide no additional cash or income to the company that owns them. Therefore, issuing them is detrimental to the company in many ways. Let's look at how it affects investors as well.

Because bonus shares do not increase the total amount of money made, profits remain constant even as the number of shares increases. This also means that investors will receive less money per share owned.

What are the tax implications of bonus shares?

Because the bonus shares are free, they are an excellent example of a capital gain. Thus, the consideration price is zero; therefore, the entire profit from selling bonus shares is considered a capital gain.

If you hold the bonus shares for a year and then sell them, you will gain long-term capital. This will be taxed at 10%. 

However, a short-term capital gain is on your side when shares are sold within 12 months of the date they were credited to each Demat account. The person who receives STCG is taxed at a rate of 15%.

Bonus shares are bad for shareholders in the short term because the stock price falls, and there are tax consequences. However, bonus shares will often pay off in the long run. 

Investors with a long-term strategy or portfolio should focus on companies that distribute bonus shares. They generate revenue for the company that manufactures them and the individuals who own them.

Most of the shareholders benefit and receive an additional number of shares. Therefore, the issuing company does not have to pay cash dividends. The equity capital gets stronger, and the goodwill also increases. Moreover, the accumulated profits are capitalized.

Things to keep in mind when availing of bonus shares

Don't believe everything you hear

No matter the source's reliability, you should only blindly follow a stock marketing tip after conducting your research. 

Always select stocks after conducting sufficient research and analysis on their performance and the companies themselves. Some tips can be extremely beneficial. But the wrong ones can quickly put you in danger.

Get rid of underperforming stocks

Forecasting whether a stock will rise after a significant drop is impossible. Understand that it is important to be realistic about what can and cannot be done in the stock market. 

So, if you notice that a stock in your portfolio is underperforming, admit your error. You have to sell it immediately to avoid further losses.

Don't go over your investment budget too quickly

Even though long-term investments outperform other types, you should invest as much as you can afford. 

Choose a fixed amount to invest and divide it among several good stocks. Rather than putting all of your money into one stock, divide it among several high-performing stocks and shares.

Do bonus shares increase the value of investments?

New investors request bonus shares from company management because they believe that more bonus shares will increase the value of their investment. 

On the other hand, bonus shares rarely add value unless the company that distributes them increases the dividend per share. Before we can understand this concept, we must first define bonus shares.

Bonus shares are free shares given to shareholders who already own stock in a company. Bonus shares are distributed in a specific manner (e.g., 1:1, 1:2, etc.). 

This means the company will issue one bonus share for every share already owned and two for every two already owned.

One question that may arise is whether a larger number of bonus shares increases the value of an existing investment. Consider the following example to see what I mean.

Assume XYZ Company's stock price is Rs100, and the company has announced a 1:1 bonus. Because of bonus shares, the number of shares in circulation increases. 

So, if there were 10 million shares available before the bonus issue, there would be 20 million afterward. Simultaneously, the stock price will fall to Rs50. 

If a shareholder-owned ten shares before the bonus issue, each was worth Rs100 (value Rs1, 000). This value will remain at Rs1, 000 following the bonus issue (20 shares x Rs50). 

As a result, the fact that bonus shares were distributed does not increase the value of an investment.

Why does the stock price fall during the distribution of bonus shares?

Following a bonus issue, the company's reserve shrinks while the bank's money grows. 

The company's book value remains constant, but the book value per share decreases due to an increase in the number of outstanding shares. 

Similarly, as the company's earnings per share fall, the stock price falls proportionally to maintain the same value (1:1, 1:2, etc.).

What is the bonus ratio in bonus shares?

If a company says it will give bonus shares at a rate of 1:10, it means that for every ten shares owned, the shareholder will receive one bonus share.

On the other hand, sometimes, a company says it will issue bonus shares at a 5:1 ratio. This means that the shareholder will receive five additional equity shares for their equity shares.

Important dates to remember in bonus shares 

You should be aware of a few dates when issuing bonus shares. This is similar to when a company pays out dividends. Those major dates are:

Date of announcement

This is the date the company's board of directors will recommend issuing bonus shares.

Such specific information is shared with the exchange, and the corresponding PDF file can be available on the NSE website under "corporate information." According to the above table, Mahindra Life will be announced on July 28, 2021.

Expiration date

You must have purchased a company share before this date to receive the bonus share. Even if you purchase the stock on the ex-bonus date, you will not be eligible for bonus shares. 

Because India uses a T+2 settlement cycle, this is the case. As a result, if you buy something on the ex-bonus date, it will not appear in your Demat account.

Record date

The record date is one day following the ex-bonus date. 

If the ex-bonus date is September 12, 2021, the record date is September 14, 2021, according to the table. 

This is the deadline and the certain date on which a company will review its records to determine which investors are eligible for bonus shares. The bonus shares are credited to your Demat account 15 days after the record date.

Guidelines to be followed by a company before issuing bonus shares

Here are the steps that the company must take to distribute bonus shares:

Call a board meeting: 

The first step is to call a board meeting. According to Section 173(3) of the Act, the notice must be sent at least seven days before the Board Meeting.

Schedule a board meeting

Next, the company must schedule a Board Meeting and set the agenda. The following conditions must be met for the meeting to take place:

1. Ensure that there are enough attendees to meet the quorum, one-third of the board's total size.

2. Put the board's decision to approve the issue to a vote at a general meeting of shareholders. This is possible with a simple resolution.

3. Ensure that the resolution is carried out.

4. The bonus shares must have a fixed ratio.

5. Determine the actual date, time, and location of the general meeting and authorize a director to send out notices.

Distribute draught minutes

Draught minutes must be distributed to all directors within the specified time frame so they can be commented on. 

A public company must submit the board resolution on form MGT-14 to the Registrar of Companies within 30 days.

Send notice for a general meeting. 

At least 21 days in advance, you have to send the General Meeting notice to approve the bonus shares issue. You should send it to all directors, shareholders, auditors, and members who are permitted to receive it.

Hold a general meeting.

The Extraordinary General Meeting must be called, and the board must be authorized to distribute bonus shares. It would help if you passed an Ordinary resolution with a simple majority, as Section 114(1) of the Act required.

Hold a board meeting.

The company must hold a Board Meeting to approve the bonus shares and ensure that all rules are followed.

Submit form no. PAS -3

A company with a share capital must file Form PAS-3, "Return of Allotment," within 30 days of issuing securities. Attachments of the following types will be required:

1. A duplicate of your Ordinary Resolution passed at the Extraordinary General Meeting.

2. A copy of the Board of Directors' decision to distribute shares.

3. A list of allotters, including their names, addresses, jobs (if any), and the number of securities distributed. The person who completed Form PAS-3 will sign this list. 

4. Any other documents that may be required.

Share certificate issuance

If the shares are being held in Demat form, the company must notify the depository immediately. If the shares are held physically, the company must issue share certificates within two months of the allotment date.

Are bonus shares worth it?

Yes, they are! When a company issues bonus shares to its employees, it boosts the value of those shares and the company's standing in the market. 

In addition to gaining the confidence of current shareholders, this also attracts many new, smaller investors to the stock market. 

The increased liquidity and capitalization of the stock are a direct result of the bonus shares issued to investors. There are no tax implications for purchasers of bonus shares.

Except in one specific circumstance, companies that issue bonus shares do not add value. Investors will see value in bonus shares if the company increases the dividend per share. 

The result is guaranteed dividend payments, an easy way to increase wealth.

FAQs: frequently asked questions

Can giving out bonus shares increase the company's value?

Yes! The issuance of bonus shares increases the company's value and strengthens its market position and reputation. This builds trust among existing shareholders and attracts several small investors to the stock market.

Who is eligible for the bonus shares?

People who owned company shares before the ex-date and record date will be given bonus shares.

What exactly is an Ex-Date?

The record date is the day following the expiration date. An investor must purchase the shares at least a day before the ex-date to receive the bonus shares.

Conclusion

Bonus Shares are extra shares distributed to a company's current owners in a predetermined ratio from the company's retained reserves when the company wishes to convert its reserves into cash.

It increases the number of shares in circulation and paid-up capital in the company. We hope this guide has helped you learn about bonus shares and how to avail of them.