Bonus Shares Explained

A bonus equals more money. However, more money to fatten your wallet and make your bank account look pretty must come from somewhere.

Investors of a company, in this case shareholders, can be rewarded in two ways; either through dividends or the issuance of bonus shares.

What is a bonus share?

Bonus shares are given to existing shareholders in proportion to the number of shares they own. Ie: recently Williamson Tea Kenya issued a 1 for 1 bonus share which traded in the market today (January 11th 2016). This meant that a shareholder would  get one additional share for each share held.

The shareholders do not pay anything for these shares.

bonus

The company issuing the bonus share builds a reserve by retaining a part of its profit over the years. When these reserves increase, the company transfers a part of the money into the capital account, from which it issues bonus shares.

At this point, only fully paid-up shares are eligible for bonus.

Impact of a bonus share

Though bonus shares do not directly affect a company’s performance. They have the following major effects:

1. Increased share capital according to the bonus issue ratio.
2. Increased liquidity in the stock.
3. Reduced EPS, BV and other per share values.
4. Accumulated profits get reduced.

Impact of a bonus share on share price

Theoretically (and sometimes in most cases), after the bonus issue, the share price of the company gets adjusted according to the bonus ratio. In the case of Williamson Tea Kenya, a 1 for 1 bonus issue is expected to reduce the stock price by almost half. This can be seen on the counter as it had it largest share price drop during today’s trading day of 23.72%. However, its market value is expected to roughly remain the same.

bonus-shares-vs-stock-splits-11-728

My take

The decision to buy (or sell) the shares of a company that issues bonus shares should be considered carefully. It is important to consider the fundamentals of the company but I believe it is important to understand and track market sentiment on the company. This I believe is what will cause the stock price to move either direction.

Kindly note that a bonus issue is a sign that the company is expanding its equity and increasing the liquidity of its shares but it is NOT an indicator for performance. Don’t be fooled

In the immediate term, I would expect to see an adjustment in the share price according to the proportion of the dilution. Therefore, it is safe to say that in most cases the share price would decline. However, in the long run the share price would depend (not entirely) on the fundamentals and of course its growth prospects.

 

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One comment

  1. Mostly companies do bonus issue to avoid paying cash dividends depending on their cashflow position,and since it increases liquidity of the shares,then investor can dispose the shares and make a capital gain.

    Like

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