Bonus Shares

Bonus Shares (also known as a 'Bonus Issue' or 'Scrip Issue') are additional, free shares that a company gives to its existing shareholders, distributed proportionally to their current holdings. Think of it as a corporate “thank you” card, but instead of a card, you get more stock. Companies typically fund these bonus issues by converting their accumulated profits, known as retained earnings, into new share capital. For instance, in a '1 for 5' bonus issue, an investor receives one new share for every five they already own. While it feels like getting something for nothing, a bonus issue doesn't magically increase the total value of your investment overnight. The company's overall value doesn't change, so the market price per share will drop to reflect the greater number of shares now in circulation. It’s like cutting a pizza into more slices; you have more pieces, but the total amount of pizza remains exactly the same.

While a bonus issue might seem like an accounting sleight of hand, companies have several strategic reasons for doing it. Understanding the 'why' is crucial to interpreting the action correctly.

• Rewarding Shareholders Without Spending Cash: This is a big one. If a company has had a profitable year but wants to preserve cash for expansion, debt repayment, or a rainy day, a bonus issue is a way to reward shareholders without paying a cash dividend.
• Boosting Liquidity and Affordability: A very high share price can discourage smaller investors. By increasing the number of shares in circulation and lowering the price per share, the stock becomes more accessible and affordable, which can increase trading volume and liquidity.
• Signaling Corporate Confidence: Management may use a bonus issue to send a strong, positive signal to the market. It implies that the company is confident in its future earnings potential and believes it can service a larger equity base going forward.
• Meeting Legal Requirements: In some jurisdictions, there are rules about how large a company's reserves can be in relation to its paid-up capital. A bonus issue can be a simple way to rebalance this by converting reserves into capital.

For a value investor, it's critical to look past the surface excitement of “free shares” and analyze what a bonus issue truly signifies about the company's health and value.

In a word: No. A bonus issue creates no new intrinsic value. The total market capitalization of the company remains unchanged immediately after the issue. The pie is simply sliced differently. If the share price doesn't adjust downward perfectly, it's usually due to market sentiment, not a fundamental change in the company's worth. Any investor who believes they've gotten richer simply because they have more share certificates is falling for a psychological trick.

A savvy investor must dig deeper and treat a bonus issue as a piece of a larger puzzle.

• Beware of Diluted Metrics: More shares mean the company's profits are spread more thinly. This directly reduces the earnings per share (EPS), a key valuation metric. If the EPS is halved, but the share price doesn't also halve, the price-to-earnings (P/E) ratio will double, making the stock appear more expensive. Always recalculate per-share metrics after a bonus issue to get a true picture of the company's valuation.
• Bonus Issue vs. Stock Split: These two are often confused but are different from an accounting standpoint. A stock split simply divides existing shares into smaller pieces (e.g., one $100 share becomes two $50 shares), often by changing the par value. A bonus issue creates new shares out of the company's profits. For the investor, the immediate financial outcome is nearly identical, but a bonus issue tells you the company is capitalizing its past profits, which can be a sign of strength.
• Focus on the Fundamentals: The ultimate question is whether the bonus issue is backed by a great business. Is it coming from a company with a strong track record of growing earnings and a healthy balance sheet? If so, the bonus issue can be seen as a sign of confidence from a competent management team. However, if it's from a struggling company with weak financials, it could be a red flag—an attempt to create a positive news story to distract from poor underlying performance.

Let's say you own 1,000 shares in ValueCorp, trading at $20 per share.

• Your Initial Holding: 1,000 shares x $20/share = $20,000

ValueCorp announces a 1 for 4 bonus issue. For every 4 shares you own, you get 1 free share.

• Bonus Shares Received: 1,000 / 4 = 250 new shares
• Your New Total Holding: 1,000 + 250 = 1,250 shares

The total value of the company hasn't changed, so the market will adjust the share price.

• Theoretical New Share Price: $20,000 / 1,250 shares = $16 per share
• Your Final Holding Value: 1,250 shares x $16/share = $20,000

As you can see, the total value of your investment remains the same. You simply own more shares at a lower price.