What Is a Bonus Issue? Meaning, Purpose, Benefits & Risks for Investors

In the world of equity investing, bonus issues are one of the most exciting actions taken by a corporation and one of the most attention grabbing for investors. Companies usually decide on bonus issues to reward investors and increase shareholder loyalty without the expense of cash dividends by issuing free additional shares.

In this, we will discuss the purpose, advantages of the issue of bonus shares, possible disadvantages of the issue of bonus shares, and most importantly, why do companies issue bonus shares.

What Is Bonus Issue?

A bonus issue is a corporate action taken by a corporation to issue additional shares which are free of charge to the company’s present shareholders, which it is done by converting a company’s cash reserves into share capital.

A bonus issue is also known as a scrip issue or capitalisation of reserves.

Example:

A 1:1 bonus issuance entitles owners to one extra share for each share they own.

Therefore, if you possess 50 shares you will get an additional 50 shares for free making a total of 100 shares.

The total number of outstanding shares rises as a result of bonus issues, but the company's overall market capitalization stays constant. This is because shares become proportionately less valuable after a bonus issue.

 

 

Why Companies Issue Bonus Shares

Companies do not issue bonus shares without a prior financial strategy. Some of the strategic reasons for bonus share allocation include the following:

1. To Reward Shareholders

Companies increase goodwill to all shareholders by issuing bonus shares. This is a fantastic goodwill booster to all shareholders in the absence of a cash dividend.

2. To Ensure Liquidity

Marketable securities become less expensive after a bonus share issue. This increase in accessibility in a proportional share price decline enhances market liquidity.

3. To Capitalise on Company Reserves

Companies that strengthen their share capital by retaining cash profits instead of distributing profits as cash also convert their cash and profits reserves into share capital.

4. To Indicate Company Confidence and Growth

An expectation of growth in profit is signalled by a company stock bonus issue and is more likely to create market positivity.

5. To Adjust Market Prices

Companies that have stock priced at a premium tend to have less market participation. Marketable bonus issues tend to move shares to a more “tradeable” price.

Bonus Share Issuance Process

Regulatory approval is obtained for the bonus issue, before steps are enacted.

1. Board Meeting: The directors recommend the bonus ratio.

2. Shareholder Approval: A general meeting polls the shareholders.

3. Record Date: A date is specified for determining the eligible receivers.

4. Bonus Credit: Bonus shares are credited automatically.

Post issuance of bonus shares, stock prices get adjusted, but the total investment value remains the same initially.

 

Advantages of Issue of Bonus Shares

Both companies and shareholders enjoy positive benefits from bonus issuance.

For Investors

1. Cost Bonus: New, additional shares are received completely free of cost.

2. Liquidity Increased: The stock is easier to trade, and more shares of the stock are available for purchase.

3. Reward Effect: Receiving a bonus is enriching psychologically and enhances loyalty.

4. Tax Exemption: Bonuses are not taxable.

For Companies

1. Retained Earnings Efficient Usage: Companies can efficiently use their free reserves.

2. Shareholder Base Bullish Expansion: New, lower prices after a bonus are more attractive.

3. Positive Market Sentiment: Announcing bonuses at the right time can capture the attention of investors and increase the company’s value.

Disadvantages of Bonus Shares

Every bonus issue carries certain risks. Here are the Disadvantages of Bonus Shares:

1. No Real Cash Benefit: Bonus issues do not pay dividends. There is no cash payout along with the new bonus shares.

2. Stock Price Adjustment: When a company issues bonus shares, the fair value of the shares is reduced proportionately. Initially, the value of the investor's portfolio remains unchanged.

3. Possible EPS Dilution: The increase in the number of shares can cause a drop in the Earnings Per Share (EPS), thereby lowering the profitability.

4. Administrative Costs: Legal and administrative costs, along with the company's regulatory obligations, can be significant.

5. False Market Perception: Bonus issues do not come with a guarantee of profitability, but many investors believe they do.

 

Impact of Bonus Issue on Stock Price

Following a bonus issue, the stock price changes in proportion to the issued bonus shares.

Example:

If a company's shares are priced at ₹2,000 and it announces a 1:1 bonus, the shares will be worth about ₹1,000 after the bonus is issued.

Your total investments remain the same as well:

Pre-bonus: 100 shares × ₹2,000 = ₹2,00,000

Post-bonus: 200 shares × ₹1,000 = ₹2,00,000

Hence, the bonus issue meaning is the redistribution of ownership without the value of total investments changing.

Bonus Issues Vs Stock Split

Although both increase the number of shares, they are not the same.

Basis	Bonus Issue	Stock Split
Purpose	To reward shareholders	To reduce face value per share
Impact on Face Value	No change	Face value is reduced
Source of Funds	Free reserves	None (just division of shares)
Effect on Share Capital	Increases	Remains same
Market Impact	Signals financial strength	Increases liquidity

 

How Bonus Issues Help Long-Term Investors

For long-term investors, these offer the most compounding benefits. More shares become eligible for future dividends. Company value appreciation directly benefits more shares. Investing in more additional bonus shares increases wealth potential exponentially.

Risks investors should understand there are reasons why someone should not be overly enthusiastic about a bonus issue announcement:

• A bonus issue does not pay dividends on its own.

• Stock prices usually respond to market changes.

• Bonus issues are more reliable once a firm demonstrates consistent earnings.
  
  

 

Conclusion

A bonus issue is one of the most shareholder-friendly ways for companies to reward investors, enhance liquidity, and strengthen equity capital. While the bonus issue offers many benefits, investors must keep in mind the downsides of bonus shares and know that bonuses don't always provide extra value instantly.

Focus first on the fundamentals of why companies issue bonus shares and analyse the company's financial performance. Also, remember that bonuses are primarily long-term signals of confidence and not short-term profit opportunities.

Bonus shares provide long-term compounding advantages, but there are other ways for investors to make consistent profits. Additionally, a lot of seasoned investors favor dividend-paying equities, or businesses that offer both prospective capital growth and consistent dividend payments. Understanding the balance between bonus issues and dividend-paying stocks can help you build a well-diversified, income-generating portfolio.

 

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.