Who doesn’t like getting a Diwali or an annual bonus at work? It shows you’re valued and adds to your capital as well. In the context of the stock market, bonus shares are a lot like those delightful surprises. Through this article, we will shed light on the meaning of bonus shares – what they are, how they work, and why they matter in the Indian stock market.
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A bonus share is an additional share issued by a company to its existing shareholders without any cost attached. This act is akin to a company acknowledging and rewarding the loyalty and trust of its shareholders. In technical terms, bonus shares are also known as “scrip dividends” or “capitalisation issues.” They are a reflection of a company’s financial health and a strategic move to enhance shareholder value.
Also Read: The Benefits of Investing in Stocks
Understanding the Mechanism
When a company decides to issue bonus shares, it does so by dipping into its reserve of accumulated profits or share premium. It’s important to note that bonus shares don’t bring in any additional funds for the company. Instead, they are a way of rewarding existing shareholders.
The Mathematics Behind It
It is important to understand the meaning of bonus shares with an example. Suppose you own 1000 shares of ABC company, and it announces a bonus issue in the ratio of 1:1. This means for every share you own, you’ll receive an additional share – free of charge.
So, post-bonus, you’ll have 2000 shares, effectively doubling your ownership. It is important to note though, that the company’s overall market capitalisation remains unchanged and the value of its stock usually reduces depending on factors, such as the size of the bonus issue and the overall market conditions.
- Enhanced Ownership: As seen in the example, bonus shares increase the number of shares you hold, boosting your ownership stake in the company. The bonus shares also allow companies to reward their shareholders, without paying any cash dividends. It is beneficial for companies that want to conserve cash or those which are not generating enough cash flow to pay dividends.
- Price Adjustment: While the share price may reduce after a bonus issue, your overall investment value remains the same. This can attract new investors as the price becomes more affordable.
- Increased Liquidity: These shares help companies increase their liquidity in the stock market.
- Signal of Confidence: Bonus shares influence investor sentiment as they reflect the company’s confidence in its financial health and prospects of growth.
Also Read: Be Aware of Buy and Hold strategy in the Stock Market
While there are benefits of issuing bonus shares, there are also some drawbacks and disadvantages.
- It can dilute the ownership of existing shareholders.
- It can be seen as a sign that a company is not generating enough cash flow.
- It can impact the Earnings per Share (EPS) of the company, an important metric of the company’s profitability.
Having understood the definition of bonus shares, it is natural if you find them resembling stock splits, and are wondering where the difference lies. While bonus shares and stock splits might seem similar, they have distinct differences.
In case of a stock split, the number of shares increases but the share price adjusts proportionally. With bonus shares, while the number of shares increases, the price usually decreases.
Record Date and Eligibility
The record date is when the company identifies the eligible shareholders who are entitled to receive the bonus shares. If you are a shareholder on the record date, you will be eligible to receive the bonus shares, regardless of when you bought the stock.
On the other hand, the ex-bonus date is one day prior to the record date. If you buy the stock on or after the ex-bonus date, you will not be eligible to receive the bonus shares.
Bonus shares might be a delightful addition to your portfolio, but how are they taxed? The taxation of bonus shares in India is a topic of interest for many investors. Here’s a brief overview:
- No Immediate Tax Implication: When you receive bonus shares, there is no immediate tax implication. The market value of the bonus shares on the date of allotment is added to your total investment in the company. This adjusted cost is used to calculate capital gains when you eventually sell the bonus shares.
- Capital Gains Tax: When you sell the bonus shares, capital gains tax applies. The holding period of the bonus shares starts from the date of allotment. If you hold the shares for more than 12 months, the gains are considered long-term, and you enjoy the benefit of lower tax rates. If the holding period is less than 12 months, it’s treated as short-term capital gains.
- Dividend Distribution Tax (DDT): This tax was earlier to be paid by the company before distributing dividends. However, the dividend income from bonus shares is now taxable in the hands of the shareholders. The DDT was abolished for individuals and Hindu Undivided Families (HUFs) from April 1, 2020.
Wrapping it Up
So, now you know the meaning of bonus shares. From understanding their workings to exploring their benefits, purpose, and potential tax implications, you’ve unlocked the door to this intriguing aspect of the Indian stock market. Bonus shares have the potential to enhance your ownership of the company and make your journey in the world of investments even more rewarding.
