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Impact of Bonus and Split of Shares - Myth Unraveled


Multiple listed companies go for a Bonus Issue or Split their shares. Do we actually understand what that means? What is the implied impact? What does it really signify? Should we get excited? Has anything really changed? Read on...

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Dear investors and friends,

In my investing experience and my interaction with various investors, I see a lot of people getting very excited and overwhelmed when a listed business offers bonus shares or splits the shares. Some are carried away without actually understanding the basis or the concept. I actually get a lot of emails asking whether a business can be bought since it is going for a split or offering bonus shares. Today, I would like to present a good perspective about the two and the difference. Once this is properly understood, all of us can take an informed decision and try to put the pieces together.

Before we move ahead, you can check out articles, if you have not yet read them. 

How to Get A Tax Free Income of Over 10 Lakhs Legally!

What Does A 100-200% Sure-Shot Profit Every Month Means

Alright, lets understand the Bonus issue first.

Bonus Issue:
When a business offers shares to others, the understanding is that, the profit and loss will be borne by investors as well (in terms of market price). Whenever there is a surplus earnings which a business makes, the patient investors get rewarded with a small part of the earnings called dividends. The rest is kept as reserves and shown in the balance sheet as well. Many companies choose to keep the entire earnings with themselves and let it grow over a period of time. This accumulates over a period of time and finally the company decides to distribute a huge chunk. Instead of doing this in terms of dividends, the businesses decide to expand their authorized share capital by increasing the number of shares. What this essentially means is that the company converts a part of their reserves into shares.

From my previous articles, I am sure you understand some basic terms. Let's try to put the above understanding in terms of an example.

Lets say that a company has issued 1 Lakh shares to the public at Face Value 10. Lets say that the reserves are 10 Lakh. The company wants to increase its share capital. Now, for a FV of 10, the number of shares for reserves of 10 Lakh is 1 Lakh shares.

Number of shares created by reserves = Reserves / FV

1 Lakh = 10 Lakh / 10
So now, in addition to the 1 Lakh shares in the market, we have 1 Lakh shares created out of reserves. This means that for every share the company has given, there is one bonus share. This comes out as 1:1 bonus issue.
Now, there will be 2 Lakh shares in the market. Now since the number of shares have doubled, the market price would halve. Essentially, please remember that market price would not change in terms of value since nothing has changed in the company in terms of its business. So, even though the number of shares have doubled, there would be no increase in the value of the holding in any way.

If the market price of the share was Rs 100, after the bonus issue, it would be at Rs 50.

Market cap before bonus issue = Rs 100 x 1 Lakh shares
Market cap after bonus issue   = Rs 50 x 2 Lakh shares

Market cap has no effect.
Now lets understand the stock split.

Stock Split:
A company's market price depends on its profitability, sustainability and future vision. As a company keeps outperforming, its market price goes up and up. There are so many companies like MRF, Eicher, Page etc which trade at a very high price. For eg, as I write this article, MRF is trading at around Rs 38000 with a Face Value of Rs 10. Lots of retail investors cannot afford to buy even 1 share of MRF since it is quoting at such a price. If an investor wants to start a SIP at Rs 10000 per month, he will not be able to buy a single share of companies trading at above Rs 10000.

Read about Getting Rich with Systematic Investment Plan here

To help all investors to participate and own shares in a business, companies go for a stock split. A stock split means splitting the stock into multiple smaller units of lesser Face Value, so that the liquidity increases. 

If a company has 1 Lakh shares of FV 10 and is trading at Rs 20000 and decides to split the shares into 5 parts, we will have each share of Rs 4000. 

Market cap before split = 1 Lakh x 20000 (FV 10)
Market cap after split   = 5 Lakh x 4000 (FV 2)

So even though the new market price becomes Rs 4000, the value doesn't change. I hope you are understanding the difference between value and price in this article as well..

Lots of punters use these opportunities to artificially raise the price and many poor investors get excited by the bonus/split news and get stuck at high levels. With a good understanding, this can be avoided.

Now with this understanding, you will be able to analyze things in a more mature way. You will not be carried away by any of these. You need to understand that, by giving a bonus or split of shares, nothing really has changed. Everything depends on how the company performs and that's all matters.

Having said this, read this article on how patience alone can create wealth in long term (Click here)

Please remember that Market cap is a function of future profits and trends and since nothing has changed, it would remain same.

Think about it :-) Any experiences?? Good, bad, ugly?? Let us know..

Also Read: Everything You Wanted To Know About Multibagger Stocks

Also Read: Systematic Investment In Stock Market

Also Read: Investment Options To Save Tax

Good luck,

Article By: Fundamental Investor

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