In the stock market, companies often make changes to their shares in ways that can affect their value and the number of shares available. Two common methods used by companies to adjust their shares are Bonus Issues and Stock Splits. While these terms sound similar, they have different meanings and effects on investors. In this blog, we’ll explain the differences between a Bonus Issue and a Stock Split in simple terms, so you can understand how each one works and what it means for your investments.
What is a Bonus Issue?
A Bonus Issue is when a company gives additional shares to its existing shareholders for free, based on the number of shares they already own. For example, if a company offers a 1:1 bonus issue, this means that for every share you own, you will receive an additional share for free. The value of your investment doesn’t change because the company’s overall value stays the same, but you now own more shares.
Example: If you own 100 shares of a company, and the company announces a 1:1 Bonus Issue, you will receive an additional 100 shares. Your total shares will now be 200, but the value of each share will decrease, keeping the total value of your investment the same.
What is a Stock Split?
A Stock Split happens when a company decides to increase the number of its shares by dividing its existing shares into smaller parts. In a stock split, shareholders get more shares, but the price per share decreases. This reduces the price of each share, making it more affordable for new investors to buy.
Example: In a 2-for-1 Stock Split, for every one share you own, you will receive an additional share, doubling the total number of shares you hold. If you own 100 shares priced at ₹200 each, after the split, you will have 200 shares, but the price per share will be ₹100.
Bonus Issue vs Stock Split: What Happens to the Share Price?
In both a Bonus Issue and a Stock Split, the price of the share will adjust according to the number of shares you receive. However, the way this happens is different for each.
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In a Bonus Issue, the price of the shares will typically fall, but the total value of your investment remains the same. This happens because you are getting free shares, but the total market value of the company stays the same.
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In a Stock Split, the price of each share decreases as the number of shares increases. This makes the shares more affordable but does not change the total value of your holdings.
Here’s a comparison:
What is the Company's Rationale?
Both Bonus Issues and Stock Splits are used by companies for different reasons:
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Bonus Issue: Companies issue bonus shares when they want to reward their existing shareholders. It’s a way of sharing the company’s profits or reserves with its investors. This often happens when the company has accumulated profits and wants to distribute them without giving out cash dividends.
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Stock Split: Companies do a stock split to make their shares more affordable and attractive to smaller investors. When the share price is too high, it may discourage new investors from buying shares. A stock split makes the shares cheaper and more accessible.
Why Do Companies Issue Bonus Shares?
A company may issue bonus shares for several reasons:
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Rewarding Shareholders: It’s a way of rewarding existing shareholders for their trust and investment in the company.
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Increase Liquidity: Issuing bonus shares increases the number of shares in circulation, making the stock more liquid and easier to trade.
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Sign of Financial Strength: A company that issues bonus shares often shows strong financial health and growing profits.
What Happens to the Company’s Finances?
Neither a bonus issue nor a stock split don’t affects the company’s financial position directly. Here’s why:
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Bonus Issue: The company may use its reserves or accumulated profits to issue bonus shares, which do not impact the company’s overall cash or earnings. The total value of shares will be divided by the number of new shares, but the company’s total assets remain the same.
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Stock Split: In a stock split, there’s no change in the company’s financial position either. It just changes the number of shares in circulation and makes the shares more affordable. The company’s market capitalization remains the same.
How Does a Stock Split Work?
A Stock Split works by dividing each existing share into smaller parts. For example, in a 2-for-1 stock split, each shareholder gets two shares for every one share they already own. The stock price gets halved, but the total value of the investment remains unchanged.
Example: If you own 100 shares of a company priced at ₹500, after a 2-for-1 stock split, you will own 200 shares, but the price per share will drop to ₹250. So, your total investment remains ₹50,000, just with more shares.
Why Do Companies Do Stock Splits?
Companies opt for stock splits when their share price becomes too high, making it difficult for new or small investors to purchase shares. A lower share price after the split makes the stock more accessible, potentially increasing its demand.
Example: Let’s say a company’s stock price rises to ₹1,000 per share, which may seem expensive for many small investors. A 2-for-1 stock split would bring the price down to ₹500 per share, making it more affordable for others to invest.
What Happens to the Company’s Finances?
Similar to a bonus issue, a stock split does not affect the financial position of the company. The value of the company does not change because of the split; only the number of shares in circulation and the price per share.
Why Should You Care About Bonus Issues and Stock Splits?
Both bonus issues and stock splits provide opportunities for investors to increase their holdings without having to spend more money. They also reflect the company’s growth and financial health. However, it’s important to note that these changes don’t increase the actual value of the company.
If you're already an investor in a company, these changes can impact your shareholding and the way you view your investment. For new investors, bonus issues and stock splits may make it easier to buy shares of a company at a more affordable price.
While both Bonus Issues and Stock Splits seem similar, they are different in their structure and purpose. Bonus shares reward existing investors by issuing additional shares, while a stock split makes shares more affordable by dividing each share into smaller parts. Understanding the differences between these two methods can help you make smarter decisions when investing in the stock market. Always remember, these changes don’t affect the actual value of the company but may provide opportunities to invest or adjust your position.
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