What Is Stock Split & Bonus Issue, Key Difference Between Stock Split & Bonus Issue

What Is Stock Split & Bonus Issue, Key Difference Between Stock Split & Bonus Issue

Stock splits and Bonus issue are very well-known corporate actions that every Retail Investor should know. These are the corporate actions often used by publicly listed companies to boost the trading volume of their stock and many other reasons.

Both of them appear to be very similar, but there are fundamental differences between stock split & bonus issue.

Here in this article, we will talk about these differences comprehensively to cover all the possible aspects and consequences of these two.

What is a Stock Split?

A stock split is nothing but the division of its existing shares into multiple new shares, although the total market capitalization of the company remains constant because as a result of the increased number of shares the stock price declines. It not only boosts the stock’s liquidity but also increases retail participation.

The most common split ratios used by the companies are 2-for-1 or 3-for-1 (sometimes denoted as 2:1 or 3:1), which means that the stockholder will have two or three shares after the split takes place, respectively, for every share held prior to the split.

Reasons for the Stock Split

You may ask why companies go through the struggle and expense of a stock split? Is it a waste of money? No, it is not a waste it contains a couple of good reasons.

First of all, and the most obvious reason for a split is usually the quite high price of the stock, making it expensive for retail investors and for investors to acquire a standard board lot of 100 shares.

Second, the higher number of outstanding shares creates greater liquidity for the stock, which facilitates trading activities and also narrows the bid-ask spread.

Liquidity provides a high degree of flexibility in which investors can buy and sell shares in the company without making a great impact on the share price.

Logically a split, in theory, does not affect a stock’s price, but in practical examples, it often results in renewed investor interest, which can have a positive impact on the stock price.

While this effect can be temporary, the fact remains that stock splits by blue-chip companies are a great way for the average investor to accumulate an increasing number of shares in these companies.

For example, if someone bought Reliance shares at the time it’s of IPO today he would be holding more than 100X times shares of the company.

Advantages of Stock split

Generally, a stock split is considered as a good buying indicator, because if the company splitting the stock it means the stock price has risen to a level at which the company had to take this decision. This signifies the growth of the company.

It becomes easier for small investors to acquire or trade the shares after the split particularly because of its more affordable price.

Investors don’t need to worry about a sock split because this whole process is regulated by the company and the stockbroker of the Investor.

Reverse Stock Splits

A reverse stock split is the opposite of a forward stock split or a traditional stock split. The company that issues a reverse stock split decreases the number of its outstanding shares. After a reverse stock split, the company’s market value would remain the same just like a forward stock split.

A company also have several reasons for a reverse stock split, a company that takes this corporate action might do so if its share price had decreased to a level at which it runs the risk of being outranged from an Index or even delisted from an exchange for not meeting the minimum price required to be listed.

What is a Bonus Issue?

A bonus issue is often termed as a capitalization issue and also a scrip issue, a bonus issue is an offer provided to the existing shareholders of a company to subscribe for additional shares and not increasing the dividend payout.

Companies offer to distribute additional shares among the current or existing shareholders. For example, a six-for-four bonus issue entitles each shareholder with six shares for every four shares they had before the issue. Assuming a shareholder with 1,000 shares receives 1,500 bonus shares (1000 x 6/4 = 1500).

Bonus shares are not taxable. But the stockholders have to pay Capital gains tax according to the duration of their holdings if they sell them at a net gain.

Reasons Of Bonus Issue

Bonus issues are generally performed by companies running low on cash. Instead of paying cash dividends as a means of providing regular income to their shareholders, a Bonus share is announced.

However, issuing bonus shares takes more money from the cash reserve than issuing dividends does. Since the issue of bonus shares increases the issued share capital of the company, as a result, the company is perceived being larger than it really is.

It also helps to make the company a lucrative investment for investors. It leads the stock price to drop down making the stock more affordable for retail investors.

Advantages of Bonus Issue

Issue of Bonus shares indirectly enhances the faith of the investors in the company because if a company is able to issue bonus shares it is a reliable sign that the company has an adequate amount of cash reserves.

A Bonus issue increases the amount of dividend that will be received by the investor as a result of an increased number of shares. Since the company’s share capital is increased by a bonus issue, Company seems to be larger than it really is.

Do Stock Split And Bonus Issue Affect Long Term Returns?

As explained above stock splits and bonus issues bring the stock price to a more affordable level. Retail and small investors typically prefer to buy stocks that are relatively denominated lower. Perform an in-depth fundamental analysis of stocks before making any investment decision.

It is true that value has nothing to do with the price of the stock but at the same time, it is also obvious that bringing a stock price into a popular price range benefits by proving more investor-friendly.

These corporate actions are proved to be essential not only in growth but also in sustaining the interest of shareholders over a long period of time.

Logically bonus issue and stock splits do not create value in financial terms but it is the psychology that is triggered by these corporate actions. They are instrumental that are used as catalysts in the process of value discovery by making stocks more affordable.

Frequently Asked Questions

Q. Do I have to pay any additional charges or Taxes on Splits or Bonuses?

No, you don’t need to pay any charges or Taxes these corporate actions are settled between your Stockbroker and the Company. Tax will be calculated accordingly to your tax slab. But, If you sell stocks under a year then you have to pay short-term capital gains tax.

Q. Are stock splits good or bad?

Stock splits are a frequently performed corporate action performed by companies to position their company stock in its optimum range. Therefore, a split is often the result of growth or the prospects of future growth, and is a positive signal. Splits do not create or destroy value of company in financial terms, but it hits the psychological sides of Investors, the price of a stock that has just split may see an uptick as new investors seek the relatively better-priced shares.

Q. Does the stock split make the company more or less valuable?

No, as mentioned above in the article, splits are neutral actions. The split decreases the stock price of a company and increases the number of outstanding shares outstanding, but its overall value does not change. Therefore the price of the shares will adjust downward to reflect the company’s actual market capitalization. When a company announce dividends, new dividends will be adjusted accordingly to the new price of stock.

Q. What happens if I own shares that undergo a stock split?

Let’s take an example, in a most commonly performed 2:1 stock split, if you owned 100 shares that were trading at RS 1000 just before the split, after the split you will have 200 shares at RS 500 each. Your broker would handle this automatically, so there is nothing you need to worry about.

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He is pursuing BBA, a Passionate trader and his hobby is to write content on business and finance.

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