About Bonus Shares and Stock Splits

Hi experts,

I need ur help.I have recently bought Havells for 572 keeping 1:1 bonus in mind.Please tell me how share bonus work.What is the basic funda behind it?What is the difference between stock split and bonus?What will be the price range of Havells after bonus.Please explain in detail.

Thanks & regards
Gopal.S

basic funda behind bonus

when a company makes profit, a portion of it is distributed among its shareholder as dividend and the remaining portion goes to the general reserve of the company which, the company, uses for various purpose, such as expansion, acquisition of other companies etc etc. but when the general reserve adds up substantially and the company does not have any plans for its utilisation it distributed the same among the shareholder, as bonus, as an reward.

thus the account effect is nothing but an increase in paid up capital and a decrease in reserves.

so if an company had an paid up capital of 10 crores and the company announced a bonus in the ratio of 1:1 the paid up capital of the company goes up to 20 crores. the reserve of the company is reduced by similar amount.

the most common perception is, by distributing bonus, the company is confident of its future growth.

lets exemplify it:
lets suppose a company has a paid up capital of 10 crores and it makes a profit of 2 crores & it distributes 1 crore of its profit as dividend. thus we can say the company distributes 10% of its capital as dividend.

now the company goes in for a 1:1 bonus. thus the capital of the company increases to 20 crores.

now the question is will the company pay a 10% dividend, which now works out be 2 crores on that expanded capital. well the answer is no. but the company will definitely pay a dividend more that what it used to pay. so if the company paid 1 crore as dividend last year, it will pay, lets say, 1.5 crore this year. percentage wise it is 7.5% on an expanded capital.

the company can only distribute a larger share of its profit as dividend only when theres a substantial rise in its profit. and bonus is a indication to that.

the concept of split.
sometimes the price rises in so much (lets take the example of TCS or Infosys) that retail investors no longer feels comfortable in buying the same. this also adversely affect the trading volume of the company.

so to increase retail participation, which in turns means increase in trading volume is the main idea behind the concept of stock split.

Thanks JDM.

JDM , I'm afraid you are misinformed about 'reserves' which appear on the Liabilities side of the Balance Sheet . This is not to be confused with reserves as we understand it in non-commerce terms. Hence 'reserves' have absolutely nothing to do with acquisition or expansion, as they are not assets but liabilities, and thus cannot be 'deployed' for buildup of other assets or for capex etc.

Issue of bonus shares thru' 'capitalisation ' of resrves is a mere book entry which has absolutely no cash implications.

The other aspect which you overlooked (to clarify) is the price of the scrip after 1:1 bonus. Well , since the floating stock will double ... and the market cap remains unchanged ... the price ex-bonus will immediately halve. Of course, depending on the market trends on that day and subsequent, it may continue rising or falling in continuation of the momentum it showed before the ex bonus date. So in reality it will not be exactly half of the cum bonus price, but nearly so.


Glad to clarify further

Rgds
AGILENT

Hi Agilent,
sorry if this is a dumb question, wanted to know if the bonus issue date is always a future date? correct me if i am wrong.

Also wanted to know about devident, say a company xyz announced bonus for the quarter ending 30th jun 2006, people who held shares on 30th jun 2006 are entitled for the devident (evene though they have sold the shares on 1st july) since they were investers on that date. People who bought shares after 1st july are not entitled for the devident. Is devident issue date is always a past date? please correct me.

Thanks in advance

Thanks in advance

Yes it is always a future date ... bonus is never issued with retrospective effect

A record date is fixed for the bonus ...after internal approvals ... and all persons who hold shares as on that date are entitled to the bonus

And remember, a bonus issue does not by itself enhance shareholder wealth ... it is a mere book entry which inflates your shareholding and simultaneously adjusts (reduces) the share price in the same proportion. But in reality, more often than not, bonus issues have positive connotations on share prices , typically lasting several months from prior to announcement (when insider start buying) to well after ex bonus date, several months later.

Hope this clarifies

AGILENT

hi agilent,

a "healthy" cash position does not necessarily means a "healthy" balance sheet. but a healthy cash position with an equally healthy reserves have a whole different story to tell. for every asset theres a liability. and one has to see how these assets are being represented. and thats the buzzword.

anyway, i think you will understand the peril of simplifying things in "layman's" terms.

well i really do not think we differ in this


i intentionally left that part out. baby-feeding doesn't really helps if your intention is to teach a man to fish.

cheers,
jdm.

JDM

That statement is conceptually flawed, my friend, and can mislead learners.

Expansion, capex, acquisitions (all examples of fresh asset buildups) are NOT 'financed' through deployment of reserves (liabilities in the B/Sheet), but by redeployment of other assets OR by raising of fresh liabilities.

Think about it : if what u say (red above) is true, then u imply that a co's reserves get depleted (i.e. liabs get reduced) when it embarks on expansion (i.e. assets enlarge). If that is so, how will the balance sheet balance ?

Don't even attempt to solve this riddle ? Pl try understand that Reserves. in accounting parlance, is totally different from Reserves in common usage. The latter connotates 'cash' or assets, whereas Resreves in the B/Sheet appear in the networth section and are liabilities, and have no cash connotation whatsoever.

Also : 'bonus' issues as they are termed in India convey a false image of a 'gift' to shareholders , somewhat akin to a Diwali 'bonus' or a salary 'bonus'. In USA it is termed a stock split. While it is true that bonus issues are generally bullish for the share price, remember they are totally neutral to shareholder value since the the enlargement in floating stock (and in individual shareholding) is arithmetically neutralised by the proportionate fall in stock price (ex-B).

Suggest u read this for a better understandinghttp://www.investopedia.com/articles/01/072501.asp

Also, its interesting to read the US SEC's definition of stock split http://www.sec.gov/answers/stocksplit.htm

Happy to clarify further

AGILENT

PS By the way, what we call a 1:1 bonus in India will be called a 2 for 1 split in US

This concept is not at all conceptually flawed neither it's mis-leading. It can be mis-leading only to a person who is not seeing it from a 360 degree angle but it won't be mis-leading to a person who knows the matter or who does not know it at all.

Please try to co-relate profit & loss account with Cash Flow Statement. What happens when a profit arises in the books?? Except to some minor adjustments which are wrikled out in the long term, some assets are created which most probably will be Cash & Debtors. If the company has same Debtor Turnover as was in the previous financial year there will be an increase in Cash Balance due to Profit made by the company. Similarly, if the debtor turnover is same as compared with that for the peer companies, a company earning more profit will certainly have more cash.

Now how that cash is to be utilized?? That cash can be distributed among the shareholders as dividend, can be used in generating fixed assets,i.e., enhancing capacity or simply may be used as war-chest for inorganic growth via mergers and acquisitions.

So, its not conceptually flawed to say that reserves are used for expansion, etc. Bonus issue is one way of utilization of reserves without touching the cash as it's a simple book entry. At the other hand, there are use of cash which does not touch the reserves at all. For example, purchase of Fixed Assets like Plant & Machinery etc. Finally, there are some transaction which cause chage in both cash and reserves, e.g., amalgamation in the nature of purchase in which case identity of the reserves except statutory reserves is not preserved.

Thus, while a huge reserve in itself will not translate into huge cash reserves as the reserves of previous years might have been used in expansion and thus might have resulted into depletion of cash balance, an increase in reserves during a certain period will most certainly translate into an increase in cash balance unless & until there have been huge debtors outstanding (usually not a case in sound businesses) or the cash had been used into expansion.

Well, Bonus are different from Split so far as face value is concerned. In a 2:1split, the face value of a Rs. 10 share quoting into market at Rs. 100 will be changed as a share with face value of Rs. 5 quoting into market at Rs. 50. At the other end, in case of a bonus issue of 1:1, the same share with Rs. 10 face value quoting into market at Rs. 100 will be changed to a Rs. 10 share quoting into the market @ Rs. 50.

Further, a stock split does not affect the Balance Sheet of a company while a Bonus issue affects the balance sheet as the reserves diminish while share capital increases.

Bonus issues are also known as "Scrip issue" or "Capitalization Issue" and are different from Stock Split. There is no need to be confused on this matter.
While Bonus issue is a mean of distributing historic reserves to the shareholdres and are really akin to diwali bonus, stock split does not involve distribution of reserves to the shareholders.

Also, what we call bonus issue in India is not called a stock split anywhere in the world. The confusion arises due to some mis-informations available on the net. Sites like mootley fool (a respected site anyway) say that bonus issue is known as stock split in the USA. But the appropriate word for Bonus Issue in the USA is "Stock Dividend" and not "Stock Split"

As can be seen from the discussion above, there are inherent differences between Bonus Issue & Stock Split. It also has impact in future. As the Book value of a shares is increased permanently due to bonus issue, the management needs to work hard to generate more profit in future so as to provide the same rate of return to the shareholders as it was doing pre-bonus issue. In simple words, to maintain the same rate of dividend, they need to generate more profits while same is not the case with stock split. Stock split are the way to generate liquidity while the bonus issue's objective is to reward shareholders which serves the purpose of stock split as well.


Agilent,

From the same source only:
http://www.investopedia.com/terms/s/stocksplit.asp
http://www.investopedia.com/terms/b/bonusissue.asp

I don't like referring to web-sites for such basic matters but your assertion made me do so.

Best Regards,
--Ashish

Well the discussion is certainly getting more interesting, and will surely be more educative for all by the time it ends

Watch this space ...

Meanwhile ... a quick question to Aca / JDM (which will help clarify conceptual differences between Bonus and stock splits/dividends) : I know in US they do not have a concept of 'par value' (unlike India) , but what about UK ?

Meanwhile also, have a look at this link , which talks of stocksplits /dividends in the same 'breath'. My initial reading conveys that there are more similarities than differences between these two (read 'Backgorund' in particular)

.http://www.fairmark.com/capgain/basis/splits.htm

But then, as I suggested, watch this space

AGILENT