(Please go to Page 1 to read about Stock Split)

Over time, this retained profit accumulates, and the company’s reserves grow. A company can decide to use some of this reserve to issue bonus shares to its shareholders.

In case of a bonus issue of shares, some amount from this reserve is utilized to increase the share capital of the company, which is in turn used to issue bonus shares. This is purely an accounting exercise.

Thus, in case of a bonus issue, the accumulated reserve of a company goes down, and its share capital increases. The number of issued shares also increase.

For example, a company has an authorized share capital of Rs. 1,00,000. It has issued 10,000 shares with a face value of Rs. 10 each. Thus, its issued share capital is also Rs. 1,00,000.

It has an accumulated reserve of Rs. 10,00,000. It decides to issue bonus shares in the ratio of 1:1 or “1 for 1” – that is, 1 bonus share for each share held. In this case, it transfers Rs. 1,00,000 from its reserves to its authorized share capital. Thus, its reserves come down to Rs. 9,00,000, and its authorized share capital increases to Rs. 2,00,000.

Using this new share capital of Rs. 1,00,000, the company issues 10,000 new shares, each having a face value of Rs. 10, and gives a new share – the bonus share – for each share held. Its issued share capital also goes up to Rs. 2,00,000.

Again, lets ask the question: Does any fundamental about the company change due to this? The issued share capital does change, but there is no other effect.

But just like a stock split, since the number of shares issued increases, the profit per share (or the Earnings Per Share – EPS) decreases by the same factor.

So, if EPS is Rs. 15 per share before the bonus issue, after a 1:1 bonus, the EPS would become Rs. 7.5. But since you would be holding 2 shares now (one old share, plus one bonus share), your share of EPS remains the same: Rs. 7.5 * 2 shares = Rs. 15, which is as before!

But, like a stock split, this has an important impact on stock price: The price of the stock also goes down by the same factor! As we discussed for stock splits, it is because of the EPS and PE.

(To learn more about the Price to Earnings or PE ratio and its interpretation, please read "What is Price to Earnings (PE) ratio?" and "Interpreting Price to Earnings (PE) Ratio").

If the PE of the stock is 20 in our example, the price would go down from Rs. 300 (EPS of Rs. 15 * PE 20 = Rs. 300 per share) to Rs. 150 (EPS of Rs. 7.5 * PE 20 = Rs. 150 per share). But again, since you would be holding 2 shares now, your actual holding remains the same: Rs. 150 * 2 shares = Rs. 300, which is as before!

So, again, there is not much change, except for the number of shares traded!

And once again, there is no reason for the market to cheer a stock split. The only positive impact it has is to increase the number of shares traded, which improves liquidity. Also, if the price of the stock is too high, a stock split makes it more affordable to own for small investors.

Why does market cheer bonus issues: Just like in the case of stock splits, the stock market interprets a bonus issue as a statement of confidence by the company. The market also likes the fact that there would be an increased number of shares available in the market for trading, which increases liquidity. These factors are considered positive, and therefore the market reacts positively!

Now, it is for you to decide: Stock Split or Bonus – Is it reason enough for you to cheer?

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