What Are Bonus Shares? – Advantages & Disadvantages

By Advisorymandi
11-October-2018 12:29:43 PM
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How does it feel when you get a fat bonus at work? Indeed, you will be quite happy. That’s what the investors of a company feel when they get the extra or bonus shares free of cost. What is a bonus share? Why the bonus shares are issued? What are its advantages and disadvantages? There are plenty of questions that must be cropping up in your mind? Let us get started and find out the answers to these questions.

 

What is Bonus Share?

Bonus shares are nothing less than a gift to shareholders of the company. It is basically rewarding the current shareholders with the additional shares without any extra cost. The bonus shares are provided to the shareholders out of the accumulated earnings or profits of a company, so it is also known as the capitalization of the profits.

It is to be noted that the bonus shares are issued to the shareholders in a ratio of the shares held by them. For example,  if an investor holds 100 shares of a company and the bonus shares are declared in the ratio of 2:1, that is for every 1 share, the investor will get 2 shares for free. That is a total of 200 shares for free and the overall holding will increase to 300 shares.

 

Why Bonus Shares are Issued by the Companies?

There are three most prominent reasons for this, which are as follows:

 

  • To reward the investors: Issuing of the additional shares is one of the ways of showing appreciation to the investors. Also, the confidence of the investors get boosted, which is altogether good for the company.
  • To increase the liquidity of the shares: When the bonus shares are issued by the company, then leads to an increase in the number of outstanding shares. As there are higher outstanding shares, the participation of the traders gets increased, which in turn increases the liquidity of the stocks.
  • To adjust the stock price: Whenever a company decides to issue bonus shares, then the prices of the stocks fall to a reasonable range. It is beneficial for those investors who were not able to buy the shares earlier because of the higher price.

 

Effects of the Bonus Share Issuance

The performance of the company does not get affected after bonus shares issue. However, it has some effects that can be both positive or negative, which are mentioned below:

 

  • The liquidity position of the company remains unaffected as no cash payment is made to the shareholders.
  • The Issue of the bonus shares increases the positive sentiment about the company among the existing and potential investors.
  • The accumulated profits of the company get
  • The Earnings Per Share (EPS) get reduced.
  • The share capital gets increased.

 

Advantages of Bonus Shares

 

  • An investor is required to pay any tax on the bonus shares.
  • When the additional shares are issued and the cash is utilized for the purpose of taking care of the business activities, then it increases the confidence among the investors about the business operations of the company.
  • If the shareholders want, then they can convert the bonus shares into cash by selling them at the higher price.

 

Disadvantages of Bonus Shares

 

  • If there is any fluctuation in the dividend rate, then it can lead to the decrease in the share prices.
  • It leads to an increase in speculation, which is not good for the company.
  • If there is an increase in the number of shares, then it is quite obvious that more dividend will have to be paid to the shareholders.
  • The stake of the shareholders may decrease if they decide to sell the bonus shares to meet their liquidity needs.

 

Should You Invest in the Shares of the Companies Issuing Bonus Shares?

When a company declares bonus shares, then it is a crystal-clear indication that it is earning profits. If you look back, then there are plenty of companies who have issued the bonus shares and the shareholders have benefited greatly. However, issuing of the bonus shares must not be seen as a parameter to judge a company before investing. It is just an additional benefit, which a company is giving to the shareholders. You must also look for the other factors such as the performance report, turnover, debts before taking the investing decision. Hence, do not just jump off over the news that the company is announcing bonus shares as it may do more harm than good.

 

Note: All information & data provided in this article is for the educational purpose as well as to give general information on the finance & economy, not to provide any professional advice or service. Views & opinions are not biased against the company and do not affect any official policy or any other agency, an organization within the content.

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Author: Advisorymandi

AdvisoryMandi is India's most trusted Stock Market Advisory marketplace covers NSE, BSE, MCX & NCDEX. Invest with confidence and harness the power of AdvisoryMandi to make smarter investment decisions in Stocks, Indices, Commodities, Forex & IPO.

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