Bonus Issues: How They Attract Investors

On an average, firms issuing bonus shares tend to see an uptick in their stock prices, often attracting new investors by making shares more affordable and bringing the stock within a popular trading range. This article will dive deep into the concept of bonus issues and also mention companies that have come up with bonus issues in 2024 

The relationship between bonus issues and stock prices has been a topic of significant discussion in financial circles. Theoretically, bonus issues increase the number of outstanding shares without affecting an investor’s proportional ownership in the company. Since bonus issue dates are announced well in advance, one would expect no major price movement upon the announcement. However, empirical studies suggest otherwise. Market behaviour often shows a noticeable price increase following bonus issue announcements, suggesting a positive market sentiment towards this corporate action.

What are Bonus Issues?
Bonus shares are additional equity shares that a company distributes to its existing shareholders at no extra cost. These are issued in proportion to the shareholder’s current holdings and represent the company’s method of converting its reserves into equity capital. Although bonus shares increase the total number of shares in circulation, they do not change the overall market capitalisation of the company. Instead, the value of each share decreases proportionately. It is important to note that these are not to be confused with dividend-paying stocks. Bonus shares simply represent a restructuring of the company’s equity base, without any cash outflow.

Why do Companies Issue Bonus Shares?
There are several reasons why companies opt to issue bonus shares: Rewarding Shareholders: It is often viewed as a sign of strong financial performance, boosting shareholder confidence.

• Enhancing Liquidity: With more shares in circulation, liquidity improves, making it easier for investors to buy and sell shares.
• Attracting New Investors: By lowering the stock price, bonus shares can make the stock more accessible to smaller or retail investors.
• Increasing Trading Activity: More shares in the market can lead to higher trading volumes, benefiting both the company and its investors.
• Boosting Market Capitalisation: Although the intrinsic value does not change, a higher number of shares often bring more visibility and interest from institutional investors.

Eligibility Criteria for Issuing Bonus Shares
In India, the Companies Act, 2013, outlines the eligibility criteria for a company to issue bonus shares. The key requirements include:

• Sufficient reserves on the company’s books to support the bonus issue.
• Provisions in the company’s Articles of Association allowing the conversion of reserves into capital.
• Approval from the board of directors and the shareholders.
• No default in payment of interest or principal on fixed deposits or debt securities issued by the company.
• No outstanding statutory dues to employees such as provident fund, gratuity and bonus.
• Partly paid-up shares must be made fully paid-up before the issue of bonus shares.
• Must comply with the guidelines issued by the Securities and Exchange Board of India (SEBI) and other regulatory bodies.

It’s mandatory for companies issuing bonus shares to meet all the eligibility criteria to avoid any legal or regulatory issues.

Guidelines for Central Public Sector Enterprises (CPSEs) for Bonus Issues
According to the guidelines issued by the Department of Investment and Public Asset Management (DIPAM), every CPSE is required to issue bonus shares if their defined reserves and surplus are equal to or more than 10 times their paid-up share capital. For other companies, the issuance of bonus shares is typically governed by Section 63 of the Companies Act, 2013, and is subject to the approval of the board of directors and shareholders.

Bonus Issues versus stock splits
While bonus issues and stock splits both result in a higher number of shares and a proportionate reduction in share price, the mechanics differ slightly. In a stock split, the face value of the share is reduced, effectively doubling the number of shares without altering the overall market value. For example, a 1:1 stock split of a share with a face value of `10 would result in two shares with a face value of `5 each, which mirrors the impact of a bonus issue.

Do Bonus Issues and Stock Splits Add Value?
Although these corporate actions do not inherently create value, they can play a pivotal role in value discovery. By bringing the stock price into a range that is more appealing to retail investors, both bonus issues and stock splits increase the stock's attractiveness. Investors are more likely to engage with stocks that are perceived as being within an affordable range, even though the intrinsic value remains unchanged. This psychological effect is key in driving investor interest and market activity.

Although neither bonus issues nor stock splits improve a company’s earnings or return on equity (ROE), they help enhance the stock’s appeal by increasing liquidity and affordability. This is particularly beneficial for retail investors who are more inclined to purchase shares when the price feels affordable. Additionally, by increasing the number of shares available, these actions can make trading easier and smoother, which boosts market activity.

For long-term investors, especially those holding high-quality blue-chip stocks, bonus issues and stock splits are generally welcomed as they can increase the stock’s popularity without affecting the company’s financial health. Over time, this can significantly boost the stock's popularity, benefiting both the company and its shareholders.