In the world of investing, numerous financial instruments and perks are available to help investors grow their wealth. One such lucrative benefit offered by companies is “bonus shares.” If you are an equity investor or planning to invest in the stock market, understanding what bonus shares are and how they can help increase your earnings is essential. In this article, we will unravel the concept of bonus shares, explore their benefits, and explain how they may affect your investment portfolio. We will also touch upon related areas such as foreign exchange markets and their impact on global businesses, which indirectly tie into stock market dynamics.
What Are Bonus Shares?
Bonus shares are additional shares issued by a company to its existing shareholders in proportion to their current holdings. Instead of distributing cash dividends, companies may issue bonus shares as a reward to shareholders. For example, if a company declares a 2:1 bonus share issuance, it means that shareholders will receive two additional shares for every share they already own.
Bonus shares are distributed from the company’s accumulated reserves, meaning they do not result in immediate cash outflows for the firm. Issuing bonus shares typically indicates that the company is performing well and has decided to reward existing investors by increasing their overall shareholding without requiring any extra investment.
For instance, if you own 50 shares of a company and it announces a 1:1 bonus share issuance, you would receive 50 more shares, doubling your total shareholding to 100.
Why Do Companies Issue Bonus Shares?
1. Enhancing Market Liquidity:
Bonus shares increase the number of outstanding shares in the market, leading to greater stock liquidity. This increased liquidity makes it easier for investors to buy and sell shares, thereby fostering healthy trading activity.
2. Rewarding Shareholders:
By issuing bonus shares, companies reward their shareholders without depleting cash reserves. This is particularly beneficial for investors who prefer to reinvest in the company’s growth potential rather than receiving cash dividends.
3. Boosting Investor Confidence:
Announcing bonus shares often signals that a company has a healthy cash reserve and robust financial performance. This bolsters investor confidence and may attract new investors to the stock.
4. Psychological Impact on Share Price:
While issuing bonus shares does not change the fundamental value of the company, the lower post-issue share price (due to an increased number of shares) often attracts retail investors who perceive the stock as more affordable. This can result in enhanced demand and potentially push the stock price higher over time.
How Do Bonus Shares Work?
Let’s look at an example to see how bonus shares work in practice. Suppose:
– You own 100 shares in a company.
– The company announces a 3:2 bonus share issuance ratio. This means you will receive three bonus shares for every two shares you hold.
– After the issuance, your total number of shares will increase to 250 (100 + 150 new shares).
However, the share price will typically adjust in proportion to the issuance. If the market price of the share was $100 before the issuance, the post-issuance share price may drop proportionally based on the increased number of shares. This ensures the company’s total valuation (market capitalization) remains the same since bonus shares do not involve any additional cash inflow into the company.
Benefits of Bonus Shares for Investors
1. Increased Shareholding:
Bonus shares immediately increase your shareholding, entitling you to a greater portion of the company’s future profits, dividends, or growth.
2. Compounding Effect:
Over the long term, receiving bonus shares can significantly amplify your returns. With a higher shareholding, you stand to gain more if the company’s stock price appreciates.
3. Dividend Growth Potential:
Though bonus shares do not involve immediate cash dividends, they increase your share count, which could lead to higher future dividend payouts (provided the company maintains or improves its performance).
4. No Additional Investment Required:
Unlike a stock split or buying more shares from the secondary market, you do not need to spend any additional money to receive bonus shares. They are issued free of cost to existing shareholders.
5. Improved Portfolio Value:
In the long run, if the company’s stock performs well, the extra shares could translate into larger profits when sold, thereby increasing the overall value of your investment portfolio.
How Bonus Shares Differ from Dividend Payouts
Investors may wonder whether bonus shares are better than cash dividends, and the answer largely depends on personal investment goals and financial needs. Here’s a quick comparison:
Bonus Shares | Dividends
- Issued as additional shares to shareholders.
- Paid in cash to shareholders.
- Adds to the investor’s shareholding.
- Increases immediate liquidity for investors.
- Best for long-term wealth creation.
- Ideal for those seeking regular income.
- Does not affect the company’s cash flow.
- Reduces the company’s reserves.
If you are investing with the aim of long-term wealth creation and capital appreciation, bonus shares might be more beneficial. On the other hand, if you rely on stock investments for a steady income, dividends may better suit your goals. A mix of both strategies can also work well, depending on your financial plan.
The Indirect Link to Foreign Exchange Markets
While bonus shares are largely a domestic market phenomenon, the performance of a company issuing bonus shares can be tied to the larger global financial ecosystem, including the foreign exchange markets. For companies that operate internationally, fluctuations in foreign exchange rates can have a significant impact on their financial health and stock performance.
1. Impact of Currency Movements on Exports/Imports:
Companies heavily reliant on exports or imports are directly influenced by exchange rate fluctuations. For instance, a weaker local currency may boost competitiveness in international markets, potentially resulting in higher revenue and profits. If such companies declare bonus shares, global macroeconomic conditions, including foreign exchange market trends, could have influenced their strong performance.
2. Foreign Investors and Bonus Shares:
Bonus shares are particularly appealing to foreign institutional investors (FIIs) who monitor global companies. A strong financial performance and bonus announcements can attract FIIs to invest in the company’s shares, further driving demand and influencing the stock price.
3. Currency Risks:
While bonus shares are generally beneficial for investors, risks linked to currency fluctuations and foreign exchange markets could indirectly affect the issuing company’s overall performance. This, in turn, impacts your returns on the increased shareholding.
Understanding these dynamics is crucial for investors who choose to diversify their portfolios by including stocks of globally-oriented companies or engage directly in the foreign exchange markets.
Tax Implications of Bonus Shares
Bonus shares often come with certain tax implications that investors should be aware of:
1. Capital Gains Tax:
When you sell bonus shares, capital gains will be calculated based on the cost of acquisition. For bonus shares, the cost of acquisition is considered zero, which means the entire sale price is subject to capital gains tax regulations.
2. Holding Period:
The holding period for bonus shares is counted from the date of allotment, not from the original share purchase date. This is essential for determining whether the gains are short-term or long-term.
Understanding these tax aspects is critical to make informed decisions and maximize the benefits of bonus shares while remaining compliant with tax laws.
Conclusion
Bonus shares can be an excellent mechanism for wealth creation, rewarding investors by increasing their shareholding without requiring them to invest additional funds. They are an attractive incentive for long-term investors seeking to capitalize on a company’s sustained performance and future growth.
Although bonus shares do not offer immediate liquidity like dividends do, they provide opportunities for compounding your returns over time, making them a popular choice among investors focused on long-term financial goals.
Additionally, while bonus shares largely operate within domestic stock markets, their implications can sometimes intersect with macroeconomic factors, including the movements of foreign exchange markets. For companies with international exposure, foreign exchange rate fluctuations play a significant role in shaping profits and, in turn, impact shareholder rewards like bonus shares.
Before investing in companies offering bonus shares, you should study their financial performance, current market conditions, and your own investment objectives. Whether you’re an individual investor or a participant in broader financial ecosystems like the stock or foreign exchange market, bonus shares can serve as a valuable tool to augment your portfolio’s earnings potential in the long run.
