Instead of paying a cash dividend, a company might decide to go for a bonus issue of shares. It’s a stock dividend allotted by the company to its shareholders out of the reserves of the company.
Each existing shareholder of the company will get free shares against that they currently hold.
One of the most important reasons why a company issues bonus shares is that it encourages retail investors participation, especially when the company’s price per share is very high making it difficult for retail investors to buy and sell shares in the open market.
Companies typically announce bonus shares in a fixed ratio such as 1:1, 1:2, 2:1, 1:3, 3:1 etc.
If the bonus issue ratio decided by the company is 1:1, then the existing shareholders get 1 additional share for every 1 share they are currently holding at no additional cost.
This means, if you are holding 200 shares, then additional 200 shares will be issued to you at no additional cost. Your holding after issue of bonus shares will become 400 shares.
Remember, when bonus shares are issued by a company, your current holding will increase in number, but the value of your investment will be the same.
Here are illustrations to understand the issue of bonus shares and its impact on stock price.
When bonus issue ratio is 1:1 (1 for 1 ratio)
| Number of shares held before bonus | 200 shares |
| Share price before bonus issue | Rs. 100 |
| Investment value | Rs. 20,000 (100*200) |
| Bonus Shares allotted (1:1 ratio) | 200 Shares |
| Shares after bonus | 400 Shares (200+200) |
| Share price after bonus | Rs. 50 (100/2) |
| Value of investment after bonus | 20,000 (50*400) |
When bonus issue is 3:1 (3 for 1 ratio)
| Number of shares held before bonus | 300 |
| Share price before bonus issue | Rs. 100 |
| Investment value | Rs. 30,000 (100*300) |
| Bonus Shares allotted (3 for 1 ratio) | 900 Shares |
| Number of shares after bonus | 1,200 Shares (900+300) |
| Share price after bonus | Rs. 25 (100/4) |
| Value of investment after bonus | Rs. 30,000 (25*1,200) |
When bonus shares are issued
The date when the company announces the bonus issue is known as the bonus announcement date. It’s the date on which the company also declares the record date.
Record date is the date on which a company looks at its shareholder register in order to find the list of shareholders who are eligible for bonus shares declared by the company.
If you are not a shareholder on the record date, then you will not be eligible for the bonus issue.
To be eligible, you need to buy the share at least 2 trading days before the record date as in India we follow the T+2 settlement period.
Based on the T+2 settlement period, we have a day which is known as ex-date.
Ex-date is the day when the company’s stock starts trading in the stock market without the benefit of bonus issues. That is why it’s also referred to as ex-benefit day. Ex-date is one day before the record date.
In order to get the benefit of bonus issue, you need to make sure that you purchase a company’s shares from the open market at least one day before the ex-date. If you do that, then your name will be reflected in the company’s shareholder list as on record date and shares will be credited to your Demat account.
Also Read: How Rights issue works on the stock market – All you need to know
