Reliance Industries has declared a Bonus issue of 1:1. WoW!!! But what does it mean? How does it affect me? Should I purchase RIL shares now?
We will try to get answers to these questions today.
Free shares of stock given to current shareholders, based upon the number of shares that a shareholder owns. While this stock action increases the number of shares owned, it does not increase the total value. This is due to the fact that since the total number of shares increases, the ratio of number of shares held to number of shares outstanding remains constant.
Where did this bonus come from?
Bonus shares are issued by cashing in on the free reserves of the company.
A company builds up its cash reserve by retaining part of its profit over the years (the part that is not used over the years to expand the capacity, pay the dividend etc.). After a while, this reserve increases, and the company wanting to issue bonus shares converts part of the reserve into capital.
So, the existing investor gets some free shares and the company's profit as well remains in-tact.
Affect of Bonus issue
A bonus issue adds to the total number of shares in the market.
Taking the case of RIL, the company has about 1,642.5 million shares outstanding. Now, with a bonus issue of 1:1, there will be another 1,642.5 million shares added. So now, there will be 3285 million shares.
This is referred to as a dilution in equity.
Now the earnings of the company will have to be divided by that many more shares.
Earnings Per Share = Net Profit/ Number of Shares
Since the profits remain the same but the number of shares has increased, the EPS will decline.
Theoretically, the stock price should also decrease proportionately to the number of new shares. But, in reality, it may not happen.
That's because:
- The stock is now more liquid. Now that there are so many more shares, it is easier to buy and sell.
- A bonus issue is a signal that the company is in a position to service its larger equity. That means, the management would not have given these shares if it were not confident of being able to increase its profits and distribute dividends on all these shares in the future.
When does it take effect?
When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus.
After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.
Then how is this different from a share split?
In case of bonus shares the value of the share decreases proportionate to the number of bonus shares issued. For example, if the company issues bonus shares in ratio of 1:1 and the price of share is 900 , after bonus issue, the corresponding value of the share gets Rs. 450. Genreally company issues this in place of giving dividends. The market captalization doesn't get affected, becuase if shares double, the prices is halved.
In case of a split, the face value of share decreases. Generally the face value of share is 10 Rs. but face value can be higher as well. So, if face value is Rs 10, then the company can split the share in ratio of 10:1. Now the person holding 100 shares of rs 10 now will hold 1000 shares of Rs 1 each. now shares can be traded more frequently and this will in turn increase the liquidity of the share.
