Bonus Shares Vs Stock Splits: How they compare?

Guide To Fundamental Research | Published on 25th June 2018 | 762

Do Bonus and stock split create value for shareholders? Let us start with the unbelievable story of how Wipro created wealth over the years. Had you bought 100 shares of Wipro in 1980 at a price of Rs.100 then your investment of Rs.10,000 would be worth a princely Rs.510 crore today. Of course, we are assuming that you just sat on these shares for 38 years and enjoyed all the bonuses and stock splits. Consider the table below!

Year Bonus / Split Ratio of Bonus / Split Year Beginning shares Year Ending shares
1980 0 100 shares (Bought )
1981 Bonus 1:1 100 200
1985 Bonus 1:1 200 400
1986 Stock Split 100 to 10 FV 400 4,000
1987 Bonus 1:1 4,000 8,000
1989 Bonus 1:1 8,000 16,000
1992 Bonus 1:1 16,000 32,000
1995 Bonus 1:1 32,000 64,000
1997 Bonus 2:1 64,000 1,92,000
1999 Stock Split 10 to 2 FV 1,92,000 9,60,000
2004 Bonus 2:1 9,60,000 28,80,000
2005 Bonus 1:1 28,80,000 57,60,000
2010 Bonus 2:3 57,60,000 96,00,000
2017 Bonus 1:1 96,00,000 1,92,00,000

The big question is did bonuses create this wealth or stock splits or both? The answer is that neither of these really created wealth in case of Wipro. What created wealth was that Wipro went from a small vegetable oil manufacturer in 1980 to being one of India’s largest IT players. It is this tipping point that created wealth for the shareholders of Wipro. But, bonuses and splits definitely helped along the way because they helped bring the share price of Wipro within affordable range for the stock markets. Otherwise, each share of Wipro would be quoting something like what Berkshire Hathaway quotes today.

What happens: Bonuses versus splits…

Both bonuses and splits result in dilution of the equity base due to increase in the number of shares outstanding. However, since the number of shares goes up and the price goes down proportionately, the net value impact is neutral. But are they really accretive? Not exactly! If you take a company that comes out with a 1:1 bonus or 10:5 stock split; you will find the number of shares doubling and the price halving. So the impact on the stock value will be neutral in case of bonuses and splits. A bonus of 1:1 (1 bonus share for every 1 share held) is the same as 10:5 stock splits (splitting the face value from 10 to 5). What does happen in both the cases is that the price comes within a more popular trading range.

Why do companies opt for stock split?

A stock split is a subdivision of the par value of the share. For example a stock with a par value of Rs.10 is trading at Rs.1800 in the stock market. If the par value of the stock is subdivided from 10 to 2, then there is more liquidity available in the market to the extent of 5 times. At the same time the stock price will come down to around Rs.360 and will give a greater comfort level to small and medium shareholders to buy these shares.

Stock splits are useful to increase the liquidity in the market and bring it within a more acceptable range for shareholders. However, many companies have been traditionally wary of stock splits as they do not prefer their company’s par value to go below Rs.10. Reliance is one such company that has always preferred to issue bonus shares over splitting its shares.

What is the benefit accruing from issuing bonus shares?

When a company issues bonus shares, it is done out of free reserves. Free reserves include your general reserves created out of profits and the share premium account. In a bonus issue, the funds are actually transferred from the reserves to the share capital of the company. To that extent it is a signal that the company does have genuine accumulated resources

Impact of bonuses and splits on the ROE and valuation…

Let us look at ROE first. A bonus involves transfer of funds from the general reserves to the share capital. The equity of the company still remains the same. In case of split, the share capital also remains the same and it is only the structure that changes. In both the cases, there is no impact on the ROE. What about valuations? By definition, both splits and bonuses are value neutral. If you are holding 100 shares and if there is a 1:1 bonus or a 10:5 split then you will end up with 200 shares. But since the net profit of the company is the same the EPS will halve. However, you now hold 200 shares, so for you it is value neutral. The big benefit of splits and bonuses is that it reduces the market price of the stock and brings it within a more popular trading range. That improves liquidity and retail participation in the stock, especially in case of stocks that quote at a higher price range.