Bonus issue: Does It Create Wealth For You?
The announcement of issue of bonus shares evokes a feeling of euphoria amongst investors. But do these bonus issues really help investors beat the market—Sensex or Nifty—returns? Tanay Loya and Yogesh Supekar discover that it takes more than the issue of bonus shares to create wealth for the investors in the long run. However, bonus announcements may be good for the short term and momentum traders.
Most long term equity investors will agree they get smitten when the company in which they hold shares declares issue of bonus shares. Very few investors will complain if the companies in which they are invested declare bonus issues. Historically, investors have created wealth in blue chip stocks such as Infosys, RIL, TCS, and Wipro that have issued bonuses from time to time. However, there is empirical evidence to suggest that wealth is also created in the stocks of companies that have not issued bonus shares at all.
Says Gunvanth Vaid, “I do not see bonus as a positive for long term wealth creation. There are examples of companies such as MRF and Eicher Motors which have created wealth for investors in the long term, but have not issued bonus shares. Bonus shares create liquidity in the counter and catch the attention of momentum investors and traders. In my view, these shares also increase volatility in the counter. Shivalik Rasayan is one counter where, before the bonus issue, hardly 400 to 800 shares used to get traded on a daily basis. But after the issue of bonus shares, Shivalik Rasayan now reflects trading volumes in the range of 5,000 to 10,000 shares on a daily basis. In the short term, I would agree that bonus issue is positive for certain shares, but not for all shares. However, for the long term wealth creation, bonus should not matter.”
So, what is a bonus issue of shares? Is it always beneficial for the investors in the long run? How have the stocks of companies that have issued bonus shares in the past performed on the bourses? Investors would be eager to find answers to these basic questions. It would be also interesting to find out whether a portfolio that is constructed only around the stocks of companies that have issued bonus shares outperforms the key benchmark indices.
What is a bonus issue of shares?
Celebrated as a bounty by the shareholders, the bonus issue of shares often takes centre-stage in the stock market, influencing stock price movement as well as investor sentiments. The bonus shares are issued from the net worth and retained profits of the company. The bonus shares are part of the net worth of the company and also forms the paid-up equity capital of the company. Bonus shares are issued to the existing shareholders in proportion to the shares held by them in the ratio declared by the company.
For example, if a company declares a bonus issue in the ratio of 2:1, then each shareholder of the company receives two bonus shares for each share held by him/ her before the issue. Thus, a shareholder holding 1,000 shares before the issue receives 2,000 bonus shares, thereby increasing the total shares held by the shareholder to 3,000 shares.
For the shareholders, an issue of bonus shares actually means issue of free shares, while for the company, it is a means to rewards its shareholders without incurring any cash outflow.
Record date and ex-date
When a company announces issue of bonus shares, a record date is fixed for the issue. The record date is the date on which the company issues bonus shares. To be eligible for the bonus shares, shareholders should own the shares on or before the record date.
In case an investor purchases the shares from the market after the record date, he/ she is not eligible for bonus shares. The ex-date is the next day after the record date. The adjustment in the price of shares after the bonus issue happens on the ex-date.
Why does the stock price fall when bonus shares are issued?
It is common to see proportionate drop in the price of shares post the bonus issue. After the issue of bonus shares, the reserves of the company decrease, while the share capital expands. The absolute book value of the company’s shares remains the same. However, the book value per share decreases as the number of outstanding shares increases. The earnings per share (EPS) also declines as the number of outstanding shares increases due to issue of bonus shares. Thus, the share price too declines in inverse proportion to the increase in share capital which helps maintain the stock’s valuation. So, if the share capital has doubled due to 1:1 bonus issue, the stock price will decline by ~50%.
"Since 2001, there have been 765 bonus issues from 630 companies. Since 2010, 180 companies with market capitalisation of Rs1000 crore have declared bonus shares."
"I am invested in Bajaj Auto since ages and what I have seen is that with the issue of bonus shares, my dividend yield has improved sharply. I have had similar experience for my investments in TCS. For me, the dividend income improved after the bonus issue for these two counters. But I cannot say the same for other investments in companies which have declared bonuses."
-Gautam Munot HNI Investor
Vineeta Sharma Head of Research,
Narnolia Financial Advisors Limited
❝Outperformance vis-a-vis market post bonus is like flipping a coin❞
Why do investors cheer bonus issue?
Issuance of bonus shares is used as a tool to increase the liquidity in the stock market as the number of shares available for trade increases and also the price per share reduces. As a layman, many investors confuse price of a share with the value of a share. Hence, bonus issues become attractive as psychologically the share is available at a lesser price than before.
Is there any evidence of outperformance by those stocks which have given bonus?
Since 2001, there have been 765 bonus issues from 630 companies. Since 2010, 180 companies with market capitalisation of Rs1000 crore have declared bonus shares. The analysis of one-year price performance of 180 such companies suggests only 83 have outperformed the Nifty. This implies that there is 46% probability of outperformance of a stock declaring bonus in a year.
History hence suggests investment gain or outperformance vis-a-vis market post bonus is like flipping a coin.
Improved liquidity and recapitalisation of reserves : -
One of the biggest advantages of the issue of bonus shares is the improved liquidity in the counter as more number of shares are traded post the bonus issue. The profit of the company remains the same even as the number of traded shares goes up. As the number of shares increases, the earning per share drops. That is also the reason why the share price drops in inverse proportion to the ratio of bonus shares issued.
The Companies Act allows a company to use one or all of the following reserves for issuing bonus shares – free reserves, securities premium account and capital redemption reserve.
After the bonus shares are issued, the reserves and surplus of the company decreases in line with the value of bonus shares issued. The issue of bonus shares capital by a company is also known as capitalisation of its reserves as the share capital of the company increases in proportion to the bonus shares issued.
How have stocks of companies that have issued bonus shares performed in the past?
We have considered data from May 2016 to May 2018 for studying the performance of stocks of companies that have issued bonus shares. We find that there are nearly 136 companies that have issued bonuses since May 2016. Out of these 136 companies, there are almost 81 companies that have generated positive returns till date and there are nearly 55 companies that have generated negative returns till date. The average returns generated by these 136 companies is 37.88 per cent.
During the similar period of two years, Sensex delivered an annualised return of 16.7 per cent.
If we consider the data for stocks of companies issuing bonus shares between May 2016 to May 2017, we find that the one-year return generated for these stocks is nearly 27 per cent. During the same time period (May 2016 to May 2017), Sensex gained by 16.8 per cent.
The above numbers suggest that if one creates an equal weighted portfolio consisting of stocks of companies that have announced bonus issues, the performance is superior to that of Sensex.
What is more interesting to note is the returns generated by stocks between the period of bonus announcement and the record date. The average number of days between the announcement of bonus issue and record date is 52 days. On an average, the stocks which have announced bonus since May 2016 have managed to generate 12.6 per cent, which is an impressive return.
Going by the historical data, it makes sense to park money in the stocks of companies that announce bonus shares and hold these stocks till the record date. This strategy may work only for short term traders and momentum investors. Out of the stocks of 136 companies that announced issue of bonus shares, there were nearly 97 stocks that notched up gains between the bonus announcement and the record date, while there were 39 stocks that delivered negative returns for the similar period.
Performance Of Stocks Of Companies Issuing Bonus Shares Between May 2016 And May 2018
We find that out of the 136 companies that issued bonus shares, there are at least 18 companies that have generated returns in excess of 100 per cent. There are 12 companies that have generated returns in the range of 50 per cent to 100 per cent for the given period and there 16 companies that have delivered returns in the range of 25 per cent to 50 per cent. There are 34 companies that have given returns up to 25 per cent, while there are 56 companies that have given negative returns since the bonus announcement.
Bonus vs stock split
While both the corporate actions viz., issue of bonus shares and stock split are considered positive for the stock in the short term, there is a difference in the way both the events are treated when it comes to taxation. Let’s say an investor purchases shares of ABC Company @ Rs100 each. If the company issues bonus shares in the ratio of 1:1, the share price will eventually drop to Rs50 per share. Now, the investor will be holding two shares of the same company instead of one, post the issue of bonus shares. When it comes to taxation, the cost of acquisition of one share, which we call as pre-bonus share, will be considered Rs100, while the cost of acquisition of the bonus share will be considered as ‘zero’ (free share).
In the case of a split issue, the cost of acquisition will be considered as Rs50 only, assuming an investor bought shares @ Rs100 and 1:1 split is announced.
Vinay Lunkad,
Chartered Accountant
Taxability of Bonus Shares Vs Share Split Of Listed Equity Shares Post LTCG Tax Amendment
Bonus Shares: Under the Income Tax Act 1961(IT Act 1961) principally by virtue of S-55(2)(aa)(iiia), the cost of bonus equity shares is considered as NIL. However, post the Long Term Capital Gains (LTCG) tax amendment for listed equity shares, the reference for determination of cost in the cases of sale of equity shares acquired before February 1, 2018, and sold after a period of one year is governed u/s 55(2)(ac) . As per S-55(2)(ac) the cost will be determined as mentioned below :-
Higher of Original cost/purchase cost or Lower of (a) Price of share as on Jan 31, 2018 or (b) The actual sale value
In all other cases the cost of acquisition of bonus shares will always be considered as NIL by virtue of S-55(2)(aa)(iiia) of IT Act 1961
From the above, various scenarios under which bonus shares are acquired and sold are contemplated below in order to get a better clarity :-
Scenario 1 :- Since the period of holding is more than one year and is acquired before Feb. 1, 2018, the sale will be considered as LTCG and cost as per S-55(2)(ac) will be considered
Scenario 2 :- Though the period of holding is more than one year, since the share is acquired after Feb. 1, 2018, the cost of the bonus shares will be considered as NIL by virtue of S-55(aa)(iiia)
Scenario 3 :- Since the period of holding is less than one year, the sale will be considered as Short Term Capital Gains (STCG) and the cost of the bonus shares will be considered NIL by virtue of S-55(2)(aa)(iiia)
Scenario 4 :- Though the bonus shares were allotted before Feb. 1, 2018, since the period of holding is less than one year, the cost of the bonus shares will be considered NIL by virtue of S-55(2)(aa)(iiia), since the cost with respect to S-55(2)(ac) will be considered only in cases of LTCG (held for more than a year) and not STCG
Normally, once the bonus shares are announced, the market price of the share comes down in tune of the bonus ratio as the shares are given without consideration and the EPS of the company also comes down in tune with the ratio of the bonus. So, the wealth in the hands of shareholders does not come down as shareholders also gets benefited with more number of shares without paying any money .
Under the pre-LTCG Tax regime :-
One used to buy pre-bonus shares and sell the pre-bonus shares immediately once the bonus shares are received and further sell the bonus shares after holding for one year whereby :- On the sale of pre-bonus shares – the short term capital loss is claimed (giving a benefit of 15% tax in case there are other taxable STCG and On the sale of bonus shares - since the shares are held for more than one year, the Long Term Capital gains was exempted u/s 10(38) without paying any tax.
This is known as 'Bonus Stripping'.
However under the p ost LTCG Tax regime, one may get benefited only to the tune of 5% of the differential tax rate between STCG and LTCG as :- On the sale of pre-bonus shares – the short term capital loss (STCL) claimed is eligible for set-off against both LTCG and STCG
On the sale of bonus shares - since the shares are held for more than one year, the LTCG, after setting off brought forward STCL, if any, is taxed @10%
To summarise, if there is no increase in price of the share after the bonus issue, then the shareholders stands at a neutral or 'no profit, no loss' scenario. However, depending on the price, quantum of STCG and LTCG, etc. one may get benefited for the essence of time.
For example :- If A purchases 10,000 shares of ABC Ltd on April 15, 2018 @ Rs100 and subsequently receives 10,000 shares as bonus in the ratio 1:1 on April 30, 2018 . A sells 10,000 shares @ Rs50 on May 1, 2018 and on May 1, 2019, sells 10,000 shares @ Rs50, then the capital gains will be computed as below :-
Nilesh Shetty
Quantum AMC
❝Bonus issue is just a notional book entry❞
Why is bonus issue of shares considered positive by investors? Is bonus shares always positive for investors? Bonus issue actually makes no difference to a company. It is just a notional book entry. What sometimes happens is, when the share price becomes a very high number, say Rs1,000 or Rs2,000, then the company declares a bonus. It reduces the value, or theoretically, optical value. Say, you have declared a bonus in the ratio of 1:1, then that Rs1,000 share becomes Rs500 per share, but your one share becomes two shares so your value of wealth is constant, so it might improve the liquidity of the shares marginally, but it has low impact on the fundamental value of a company. It is just a notional book entry.
Is bonus issuance of shares anything positive for the investors?
Apart from some impact on improving liquidity of the shares, it really doesn't impact the fundamentals of the business. It actually has no impact on the company.
Empirically, have you noticed outperformance from those shares that have declared bonus?
I have actually not seen that study. What you will have to do is, you have to track all the companies from the date they have declared bonus, and from that point on track the performance whether it had been any different from the companies that have not declared bonus. It is a very complex study actually. I have currently not seen any study.
Is there any pattern in types of companies that have a tendency to declare bonus issue of shares?
I don't know if there is any pattern, but by and large, companies whose share price has risen over a period of time and if the liquidity is a lot lower than what its management desires, they are the ones who tend to declare a bonus issue of shares.
Conclusion :- While the average performance of all the stocks of companies that have issued bonus shares does look impressive, it is not recommended that investors should add a stock in the portfolio only because the company has announced bonus. There is some evidence of short term outperformance in the stocks of companies that announce bonus running up to the record date, however it will be incorrect to expect wealth creation from the stock only because the company has a track record of issuing bonuses.What bonus issue essentially does is to improve the liquidity in the underlying scrip and that may lead to better price discovery. A bonus issue does not have any material or fundamental impact on the stock or the company and does not always ensure exceptional returns on the stock market. The issue of bonus shares may increase the stock’s liquidity and thereby increase the traded volume in the long run. The stock price movement depends on a combination of factors such as past and current earnings, future growth prospects and dividend pay-outs. Thus, a bonus issue of shares is only an additional benefit for the shareholders and not a determining factor of the company’s future prospects. Investors demand bonus shares from the company management as there is this perception that more shares would increase the value of their investment. On the contrary, bonus shares do not add value or create wealth, unless the company which is issuing the bonus shares maintains or increases the dividend pay-out per share.