The company shareholders have a massive role in their success as they have played a part in it by their investment. Most of the companies take it on them to reward all the investors who have purchased the shares. While gifts and parties are some of the ways the investors are rewarded, many companies provide more than that and reward them by giving an option to enhance their investments. Two of the options that companies offer to these investors are Bonus Stocks or Stock split. This blog will discuss both these options and the main differences between them.
Bonus Stocks are also known as bonus issues where the investors are issued extra dividendsin a specific ratio. Let us consider a bonus stock of 5:1 is given, and the investor has ten stocks with her, now she will receive 50(5×10) extra shares as a reward.
Though the number of shares increases, the value of individual shares tends to come down. Consider the below illustration to know how it works.
Let the bonus stock issued be of Ratio: 5:1
Let the Stock price before the bonus issue be: Rs 100
Total share count before bonus issue: 100 shares
Share count after bonus issue: 500 shares
Stock price after bonus issue: (100*100)/500= Rs 20
In bonus stock issues, the stock price falls in the same proportion as the bonus issue. Had the bonus issue been in a 1:1 ratio, the stock price would have halved to Rs 50.
Contrary to bonus stocks where extra stocks are issued, in stock Split, the existing shares are multiplied or split. So, there is no new stock being given here despite the number of shares in the hands of an investor goes up.
Let us consider a stock that is split in the ratio 1:4, and the investor has ten stocks with her, now the ten stocks will break to become 40 stocks. Unlike bonus stocks where the extra stocks received will be reflected in the book, the case is different.
What difference it means to the investors and companies.
A company uses both methods to reward its shareholders. Shareholders do not have to pay anything extra in the case of a stock split or a bonus issue.
Existing shares are split in a stock split. The liquidity increases in terms of the number of shares, the price of each share decreases, but the total investment is unaffected by the stock split.
Many businesses view a bonus issue as an alternative to dividends. Dividends are payments made to shareholders from a company’s net profits; bonus issues are also payments made to shareholders but in the form of additional shares. It raises the company’s share capital and makes it more appealing to investors.
It is also an excellent way to increase retail participation. If the stock is trading at a high level, it may not be easy to purchase. A bonus issue broadens a company’s equity base and increases its liquidity. On the other hand, a company may announce a stock split if it wishes to lower the price of its shares and make them more affordable to investors. This is also done to improve the liquidity of the company’s shares.
A stock split and a bonus issue increase the number of shares and lower the market value, but only the stock split affects the face value. This is a significant distinction between a bonus issue and a stock split. The issuance of bonus shares indicates that the company has generated additional reserves to transfer to its share capital. A stock split is an excellent option where expensive stocks are made available to many investors.