Stock split or bonus issue: Which one is better for your portfolio? | Stock Market News
Source: Live Mint
Stock splits and bonus issues are two of the most popular instruments used in the Indian stock market by the firms to reward their shareholders and thereby create market liquidity.
Now it is a given that both provide for an increase in the number of shares, still both are used for distinct purposes and have varied effects on investors. Five key points are given below that can be used to understand the difference between stock splits and bonus issues better:
Definition and purpose
A bonus issue is the issue of free extra shares to existing shareholders, usually from the retained earnings of the company. This increases the dividend for the shareholders, and they can hope that the company has sound finances thus more investors are attracted. A stock split on the other hand is splitting the existing shares into even smaller ones. This leads to a drop in the price per share and face value, thus shares become accessible to new investors.
Effect on share price and face value
Where there is a bonus issue, the face value is unchanged but the share price falls on the issue of new shares. A 1:1 bonus issue, for instance, halves the share price. A stock split, however, reduces both share price and face value in the same proportion as the split one. A 2:1 stock split, for instance, halves the face value and share price.
Tax effects and long-term consequences
Stock splits and bonus issues have no immediate tax effect to the shareholders. Tax is, in fact, levied on capital gains at the time of sale of shares. Bonus issues in the long run are useful to establish trust among investors as a result of representing power sourced from money, while stock splits enhance liquidity and accessibility, thereby potential contributor inclusion. That is why both have distinct roles for shareholders.
Impact on shareholder positions
In a bonus issue, shareholders receive additional shares, their holdings remaining unchanged without affecting the investment value. An example of a 4:1 bonus issue would raise holdings from 10 shares to 50 shares, this simply means that the total shares are increased to five times the original amount. Stock split on the other hand has the shares increased but the investment value does not change. An example of a 1:2 stock split would double the shares for the investor.
Bonus issues are an alternative to dividend distribution by companies as they distribute the reserves to the shareowners. Stock splits are used for liquidity purposes as they reduce the price of shares. This creates a high level of dealing with increased retail involvement.
Source of issuance
A bonus issue is funded from the company’s reserves or retained earnings, reflecting the company’s strong financial health and profitability. In contrast, a stock split does not involve any cash outflow or reserve adjustment; it is simply a structural change aimed at increasing liquidity and making shares more affordable.
For example: There was a stock split in Eicher Motors on 24th August 2020. Where for every share held, the holder received 10 shares post the split adjustment.
Conclusion
Therefore, shareholders should be informed of the differences so that they can make sensible portfolio decisions. Both schemes are good for shareholders, but both have differing impacts on share price, shareholdings, and market mindset. The investors should be aware of these before responding to such corporate developments by the companies.
