Difference Between Bonus Share and Stock Split

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The shareholders of a company are an integral part of a company as they play a major role in the growth and expansion of a company. Therefore, it becomes important for a company to take care of the interests of their shareholders. In order to protect the shareholder’s interests the company rewards them with several corporate actions and two of them are bonus shares and split shares.

Therefore, it becomes important to identify how to select good stocks for the long-term and benefit from these actions and to do that there are some important ratios you must know before investing.

Let’s understand the difference between stock split and bonus shares. Meanings, and their uses, how it works in favor of investors and Can government employees invest in the share market.

What is a Stock Split?

Stock split means a corporate action where the face value of a share is divided further while the number of shares gets multiplied by the same factor. When the share split of a company takes place, the face value of the share decreases while the market capitalization of the company remains the same resulting in an increase in the number of shares.

Let’s consider an investor is holding 100 shares of Rs.5 face value each and a share price of Rs.10. After a stock split of 5:1, the investor will be left with 100 x 5 =500 shares, whereas the face value of the share will be 5/5 = Rs.1 and share price will be 10/2 = Rs.2 each share.

Reasons for stock split

The primary advantages of stock splits are that such action increases the liquidity of their shares and makes them more affordable for small investors. Do you know MRF share is the most expensive share in India, which is not affordable for the Small investor to buy.

Recent example is Tata Steel stock split in the ratio of 1:10 and Bajaj Finserv stock split in the ratio of 1:5. The only difference the stock split creates is that the number of shares the investors possess increases whereas the investment value remains the same.

The stock bonus works on similar lines with the stock split but the face value of the company’s shares remains the same. where the bonus shares are issued to the existing shareholders of the company for free without any tax implications.

The rise in the share capital of the company due to the increase in the number of shares as part of the stock bonus is deducted from the company’s reserves. Though the issuance of bonus shares is a positive action yet Sebi guidelines for the issue of bonus shares are there in place and companies must adhere to these guidelines while issuing bonus shares.

For example, an investor is holding 100 shares of Rs.5 face value each and a share price of Rs.10. After a share bonus issue of 4:1, the shareholder gets 4 new shares for each share he or she owns of the company.

After this action, the face value of shares with the investor will remain the same as Rs.5, whereas the total no. of shares will increase to 100 + 100 x 4 = 500 shares and the share price will be 10/(1+4) = Rs.2. Just like the stock split, here also the investment value of the shareholder will remain unchanged.

The major advantage of bonus shares is that it gives additional shares to the shareholders resulting in the increased liquidity of these shares without any tax implications.

The following are some of the key difference between stock split and bonus shares:

1). Meaning

Stock split is the corporate action of dividing the outstanding shares into multiple shares in a set ratio where as bonus shares mean generating additional shares to reward the existing shareholders from the company reserves.

2). Expression in the books

A stock split in the ratio 5:1 or 3:2 with the right side being the original no. of shares and the left side showing in how many pieces these shares will be divided.

While the Investors receive bonus shares the left side denotes the number of extra shares available above the original number of shares on the right side. A 1 for 2 ratio denotes that each shareholder with 2 shares will get 1 extra share.

This means that if someone has 10 shares then that person will get 5 bonus shares. But a shareholder with 11 shares will also get only 5 shares as he or she is eligible for 1 bonus share only for every 2 shares that person holds.

For example, if you hold 10 shares of a company, then after a 2:1 stock split, the total number of shares will be 20. While for a bonus of 2:1, you will get 20 extra shares for 10 shares which means that the total number of shares will become 10+20 = 30 shares.

3). Face Value

In a stock split, a company splits its existing shares in a set ratio (say 5:1), while the market capitalization of the company remains the same. It results in a change in the face value of the shares as the face value is divided in the same factor as the share split.

On the other hand, in bonus issues of shares, the face value of a share doesn’t change as in this case companies generate additional shares from their reserve profits. Thus, we can see that the bonus shares are issued to existing shareholders like a dividend in the form of bonus stock issuance which is also deducted from the reserves.

4). Frequency

After stock splits when the face value of a share reaches Rs.1, it cannot be divided further.

On the other hand, a company can theoretically do as many stock bonuses as it wants theoretically as it has no impact on the face value of the stock.

5). Rationale behind these actions:

The major reason behind a stock bonus issue is mainly to reward existing shareholders. It is like a dividend paid out in the form of additional stock.

Despite using the reserves to pay out cash dividends, the company is using those reserves to hand out more shares to its existing investors. As a bonus share issue is especially the capitalization of profits, such actions always increase the credit worthiness of the company and are seen as a good sign of management confidence by investors.

Whereas, the major rationale behind the stock split is to reduce the company’s share price to desirable levels without negatively affecting the company. The major driving force behind such a decision is to increase retail participation and to increase liquidity of the share.

Generally, the companies that split their stocks are good performing companies having high share prices and thus they can become a good option to give to your dear ones. Hence, you should know how you can gift stocks to your family and friends and how to open a demat account for them if they don’t have an existing one.

Conclusion

We can say that although a stock split or bonus issue does not have a direct impact on a company’s fundamentals, these are desirable corporate actions which companies take to increase retail participation and can be seen as indicators of investor confidence and retail interest in the company.

Whereas, an investor must be vary that although these signs show management’s positive outlook for the company but it cannot be the sole factor before you invest in a company as you need to analyze the overall performance of the company and its fundamentals as well.