Companies have different ways to reward their shareholders. The reward can either be given in the form of dividends or extra shares. Bonus issue and stock split are two of them.
What is a Bonus Issue?
A bonus issue is when existing shareholders get extra shares in a certain proportion. For example, if a 4:1 bonus issue is announced, shareholders will receive four shares for every one share they hold. So if an investor holds 10 shares of a certain company, the investor will get 40 (4*10) shares in total.
What is a Stock Split?
A stock split is when the number of shares gets multiplied. There is a ‘split’ in the number of shares held. Technically no new shares are being issued by the company. The existing number of shares are being divided or split. Say a company announces a stock split in the 1:2 ratio. It means for every 1 share held, it will become 2 shares, for every 100 shares held, the share count will become 200 shares.
Since we have the basic understanding of what these two terms mean, let’s go deeper into what happens to the share value, why does a company conduct these activities and a real example to understand both the concepts.
Bonus Issue vs Stock Split: What Happens to the Share Price?
In the bonus issue, the stock price will get adjusted according to the bonus number of shares issued. Say a company announced a bonus issue, like in our earlier example, in a 4:1 ratio.
Bonus ratio: 4:1
Stock price before the bonus issue: Rs 100
Total share count before bonus issue: 100 shares
After bonus issue
Share count: 400 shares
Stock price after bonus issue: (100*100)/400= Rs 25
In bonus issue, the stock price falls in the same proportion as the bonus issue. Had the bonus issue been in a 1:1 ratio, the stock price would have halved to Rs 50.
In a stock split as well the share price gets halved in the ratio.
Stock split ratio: 1:2
Stock price before stock split: Rs 100
Total share count before stock split: 100 shares
After stock split
Share count: 200 shares
Stock price: (Rs100*100shares)/200 shares
Face value is the value of stocks listed in its books and share certificate. It remains fixed and is decided at the time of issuance unless there is a stock split. In a stock split, since the same shares are being split in a certain ratio, the face value also gets split in the same ratio.
In the above example
If the face value was Rs 10 before stock split, it will become Rs 5 per share after the split.
Share Split vs Bonus Issue: What Does it Mean for You?
Both methods are ways a company can use to reward its shareholders. In both, stock split and bonus issue shareholders don’t have to pay anything extra.
In a stock split, existing shares get split. The liquidity in terms of number of shares increases, the price of each share decreases but the total investment does not get impacted due to the stock split.
|Bonus Shares vs Stock Split|
|No.||Bonus Issue||Stock Split|
|1.||Meaning||Bonus issue is extra shares given to shareholders free of cost.||Stock Split divides the existing outstanding shares of the company into multiple shares.|
|2.||Example||For a 4:1 bonus issue, shareholders will receive four shares free for every one shareheld. So for 10 shares, will get 40 (4*10) shares in total.||In a stock split in the 1:2 ratio, for every 1 share held, it will become 2 shares, for every 100 shares held, share count will become 200 shares.|
|3.||Face Value||No change||Reduces in the same ratio|
|4.||Company Rationale||An alternative to dividend and giving away accumulated reserves||To increase share liquidity, reduce share price and make it affordable for more shareholders.|
What is the company’s rationale?
This is another key difference between bonus issue and stock split.
A bonus issue is considered as an alternative by many companies to dividends. In dividends, a company gives out extra money to shareholders from its net profits, in a bonus issue the shareholders are given extra shares. It increases the share capital of the company and makes it attractive for investors.
It is also a great method to increase retail participation. The stock may become a difficult purchase in case it is trading very high.
Bonus issue expands a company’s equity base and makes it more liquid.
On the other hand, a company may announce a stock split when it wants to reduce the price of shares and make it more affordable for investors. This is also done to increase the liquidity of the shares.
To Sum Up
Both, stock split and bonus issue multiply the number of shares and bring down the market value however it is only stock split that has an impact on the face value. This is a key difference between bonus issue and stock split. Bonus issues indicates that the company has generated extra reserves that it can transfer to its share capital. Stock split is an initiative to make expensive shares available for a larger shareholder audience.