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In the ever-evolving landscape of the stock market, companies often employ various strategies to enhance shareholder value and maintain investor interest. One such popular strategy is the issuance of bonus shares. The term “bonus issue of shares” refers to a corporate action in which a company distributes additional shares to its existing shareholders free of charge, based on the number of shares already held.

This article explores the timing and reasons behind this practice and its implications for stakeholders, using key terms such as bonus issue of shares and earning per share.

Understanding Bonus Issue of Shares

Bonus shares are units of stock distributed at no cost to shareholders. The allocation is done in a predefined ratio, such as 1:1, 2:1, or other divisions.
For example, a 1:1 bonus issue implies that an investor holding one share will receive one additional share, doubling their total to two.

Timing of Bonus Share Announcements

Companies typically announce bonus shares during specific financial periods for various strategic reasons:

1. Post-Profit Reports
   After reporting strong profits, companies may reward investors with bonus shares, boosting investor sentiment and potentially stock value.
   
   

2. Rising Stock Prices
   When stock prices rise significantly, bonus shares can make them more affordable, lowering the entry barrier for new investors.
   
   

3. Corporate Milestones
   Bonus shares may be announced to celebrate anniversaries, mergers, or major project completions, fostering shareholder loyalty and engagement.

Reasons for Bonus Issue of Shares

Issuing bonus shares serves several strategic purposes:

1. Increased Liquidity
   More shares in the market enhance liquidity, improving ease of trading and potentially boosting market activity.
   
   

2. Improved Marketability
   Lower share prices post-bonus can attract smaller investors and expand the shareholder base.
   
   

3. Adjusted Earnings Per Share (EPS)
   EPS = Profit ÷ Total Shares. Issuing bonus shares increases the number of shares, which can dilute EPS unless profits grow accordingly.
   
   

4. Signal Financial Health
   Announcing bonus shares reflects confidence in future earnings, reassuring existing investors and attracting new ones.
   
   

Calculating EPS and Share Price Impact

Example:

• Company Profit: ₹20 million
  
  

• Shares Outstanding: 1 million
  
  

• EPS = ₹20
  
  

If the company announces a 1:1 bonus issue, shares double to 2 million:

New EPS=₹20,000,0002,000,000=₹10\text{New EPS} = \frac{₹20,000,000}{2,000,000} = ₹10New EPS=2,000,000₹20,000,000​=₹10

EPS is halved. Share price may drop proportionately, although actual market response varies.

Bonus Shares: Pros and Cons for Investors

Upsides

• Increased Shareholding: More shares without extra investment
  
  

• Enhanced Liquidity: Easier buying/selling of shares
  
  

• Confidence in Growth: Indicates positive future outlook
  
  

Downsides

• EPS Dilution: Lower earnings per share
  
  

• Share Price Adjustment: Market may reduce the price
  
  

• No Immediate Cash Gain: No direct monetary benefit
  
  

Disclaimer

Trading decisions, including reactions to bonus share announcements, must be based on thorough analysis. Investors should consider factors such as earning per share, company fundamentals, and market trends before making any move. While bonus issues may reflect sound financials and a company's confidence in its performance, they also carry inherent risks. Therefore, it is crucial for investors to conduct independent research or consult financial advisors to make informed decisions.

Conclusion

Issuing bonus shares is a strategic tool companies use to enhance shareholder value, improve stock visibility, and optimise earnings per share. While it offers potential benefits, the associated trade-offs require careful consideration. Understanding the timing, reasons, and impact of bonus shares is essential for informed investing.