Unlocking Bonus Share Secrets: A Quick Guide

The world of investing can often feel like navigating a dense jungle, filled with jargon and complex strategies. One term that frequently pops up, particularly in the Indian stock market, is "bonus share." But what exactly are they, and how do they impact your investment portfolio? Let's demystify this concept.

What Exactly Are Bonus Shares?

Imagine a company has accumulated significant profits, but instead of distributing all of it as dividends, they decide to reinvest a portion back into the business. One way to do this is by issuing bonus shares. Think of it as a company giving its existing shareholders "free" shares. These shares are issued in proportion to the number of shares an investor already holds. For example, a 1:1 bonus issue means you'll receive one bonus share for every one share you already own.

The company essentially capitalizes its reserves and surplus funds to issue these bonus shares. This increases the number of outstanding shares without affecting the company's overall market capitalization. This is a crucial point to understand. While you get more shares, your overall percentage ownership in the company remains the same (assuming no other changes in shareholding).

Why Do Companies Issue Bonus Shares?

There are several reasons why a company might choose to issue bonus shares. One primary reason is to signal confidence in the company's future prospects. Issuing bonus shares suggests that the company is performing well and expects to continue doing so. It's a positive message to the market.

Another reason is to increase the liquidity of the stock. By increasing the number of outstanding shares, the price per share usually decreases, making it more affordable for smaller investors to buy. This can lead to increased trading volume and better price discovery.

Finally, companies might issue bonus shares to retain earnings within the business. Instead of paying out cash dividends, which are taxable for shareholders, they can issue bonus shares, effectively reinvesting the profits back into the company for future growth.

Impact on Investors: More Shares, Same Value?

So, you receive bonus shares. Does it mean you've instantly become richer? Not necessarily. The underlying value of your investment remains the same. Let's illustrate with an example:

Suppose you own 100 shares of Company XYZ, trading at ₹100 per share. Your total investment is ₹10,000. The company announces a 1:1 bonus issue. Now you own 200 shares, but the share price will likely adjust downwards to around ₹50 per share (assuming no other market factors influence the price). Your total investment value is still approximately ₹10,000 (200 shares x ₹50/share). The pie is simply divided into smaller slices.

However, there are potential benefits. A lower share price can attract more investors, potentially leading to increased demand and future price appreciation. Moreover, the increased number of shares could lead to higher dividend payouts in the future, assuming the company maintains its dividend policy.

Bonus Shares vs. Stock Splits: What's the Difference?

Bonus shares are often confused with stock splits, but there are key differences. Both increase the number of outstanding shares and decrease the price per share. However, a stock split is typically done to make the stock more affordable and increase liquidity, whereas a bonus issue is often a signal of confidence and a way to capitalize reserves. Furthermore, bonus shares are issued from a company's accumulated profits or reserves, while a stock split simply divides existing shares into a greater number of shares.

Tax Implications of Bonus Shares

In India, bonus shares themselves are not taxable at the time of issuance. However, when you eventually sell these bonus shares, the capital gains tax will apply. The cost of acquisition for bonus shares is considered to be zero (unless the shares were acquired before February 1, 2018, in which case the cost of acquisition is determined based on the market value on that date). This means that the entire sale price will be considered as capital gains, and you'll be taxed accordingly based on whether it's a short-term or long-term capital gain.