• Bonus Shares vs Stock Splits Comparison: Which is Better?

    by  • 17 February, 2013 • Investment Tips • 2 Comments

    Bonus Shares v/s Stock Split

    Often, we see many companies announce either stock split or bonus share. But for layman who does not understand the nitty-gritties of finance, especially to small investors, they look same. Both, bonus share as well as stock split, results in an increase in number of shares. So, what is the fundamental difference between the two, let’s find out.

     

    Stock Bonus:

    Bonus in our daily life means a gift or extra return added to what is expected. Similarly, in equity markets, stock bonus implies getting free additional shares in proportion to the amount of shares an investor is holding. When a company decides to issue bonus shares in the ratio of 1:1 or ‘1 for 1’ it means that the company would provide one bonus share for each share you hold of the company i.e. the number of shares you hold would double! It can also be interpreted as instead of receiving cash dividends, the investor would receive dividend in the form of shares.

    How does Stock Bonus affect investors?

    After the issue of bonus share, the price of the stock falls in proportion to the bonus shares issued. For example, you hold 10 shares of $30 each, the net worth of the shares with you is 10*$30 i.e. $300. The company now announces 1:1 bonus. Post it, you would hold 20 shares and the price of each share would ideally fall down to $15. Thus, your total wealth post bonus would be 20*$15 i.e. $300 which is the same as it was pre bonus. Therefore, stock bonus does not immediately affect the investors in any way. By issuing bonus shares, company gives strong signal that it is confident about its future growth which may lead to increase in demand of shares and hence move the price upwards. In the long run, there may be histrionic increase in your wealth! Also, no money is paid to acquire bonus shares and hence, while calculating capital gains tax, bonus shares are valued at nil.

     

    Why company issues Stock Bonus?

    From company’s reserves and surplus point of view, issuing bonus is like giving out 100% dividends. By issuing bonus, the company’s share capital increases permanently.Increase in the number of stocks accompanied with decrease in stock price improves affordability. It leads to improvement in float and liquidity of the stock. The traded volume of the stock increases as a cumulative effect. The hidden message which the company passes on to its investors is the confidence of servicing larger equity base.

    Stock Split:

     

    Split in daily life means forcibly break up into parts. Likewise, stock split connotes a corporate action in which the existing shares of the company are divided into multiple shares. It is like sharing a glass of drink into two glasses. The shares are always split up in a particular ratio of the existing ones. Ratio of 2:1, 3:1, 3:2 are most common, although any ratio is possible. While the number of outstanding shares increases by a multiple, but the total dollar value of the stock remains the same. The resultant shares have a lower market price as well as lower par value.

    How does Stock Split affect investors?

    Let’s take an example of 3:1 stock split. This implies the company’s shares will now trade at one-third the price of closing the previous day. Thereby, you will own three times the number of shares and the total number of outstanding shares of the company will increase by three times. Since, the number of shares issued increases, price per share and the profit per share decreases in proportion to the split ratio. Overall profit to investor remains same.

    Sometimes, the stock prices tend to upsurge after stock splits. This is due to the increased liquidity which attracts more investors. It reflects confidence of the management that they anticipate further price increase from the current levels. These factors are considered affirmative, and therefore the market reacts positively!

    Why company splits up stocks?

    If there is no difference to the wealth of the investor, then why does a company announce a stock split? Stock split makes the shares reachable, within the means, which were previously dreadfully expensive. Post the split, the price adjusts proportionate to the ratio of split. Rudiments of the company do not change, the market capitalization, revenue, earnings all remain the same too! Split is provoked when the management thinks its stock price has risen and is out of the ‘widely held trading range’.

    Tax implications of stock split:

    There aren’t any tax implications of stock split. However, on sale of shares, the capital gains tax implications are applicable. The cost of each share has to be reduced by increasing the number of shares and hence keeping the total dollar-value same as before.

    Conclusion:

    In bonus issue, the capital of the company increases and the reserves decreases. While in a stock split, the capital of the company remains same. However, in both cases, the net worth of the company remains unchanged.

    So, if you are an investor, rejoice when you get bonus shares but not when your company splits stock. It’s is just a procedural change in the face value of the stock. But if you are eying to buy shares, now, they are economical!

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    2 Responses to Bonus Shares vs Stock Splits Comparison: Which is Better?

    1. jayant rao
      24 February, 2013 at 3:44 am

      very well aptly explained.

    2. ashish jain
      24 February, 2013 at 5:38 pm

      nicely explained…………

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