Stock market investments are gaining ground in India. The potential to earn handsome returns has become a major point of attraction for equity investors. The invested capital appreciates over a period of time, but capital appreciation is not the only factor that influences returns. Companies also pay dividends or allot bonus shares, which can amount to additional value creation. In 2017-18, Indian companies together paid Rs 1.8 trillion in the form of dividends. Dividend payouts or bonus share issues are tools of transferring a part of the profit to shareholders.
What is a bonus share issue?
If a company wants to share a part of its profits with its shareholders, what avenues does it have? It can simply transfer cash in the form of dividends. But what if the company doesn’t want to transfer cash? A bonus share issue is an ideal option. It doesn’t involve cash flow but transfers wealth to shareholders. A bonus share issue the allotment of additional shares to the existing shareholders of a company without any extra cost. The shares are allotted in the proportion of existing ownership. Bonus share issue also helps in improving the equity base of the company and boosts retail participation by lowering the price of the shares. If a company announces a bonus share issue of 5:1, it means for every share owned by an existing shareholder, he/she will be allotted five new shares. The creation of new shares simply lowers the share price and reduces the threshold for entering the stock counter.
Eligibility for bonus share allotment
Companies decide the eligibility to receive bonus shares through the record date. Trading remains open after the announcement of a bonus share issue with new shareholders being added and removed every minute. But with rapidly changing number of shareholders, how do companies decide the identity of existing shareholders? Companies intending to allot bonus shares announce a record date to determine the number of existing shareholders. You have to be a shareholder on the record date to be eligible for bonus share allotment.
On the record date, the bookkeepers of the company check the records to identify shareholders. Companies also announce an ex-date while declaring a bonus share issue. The ex-date is the last trading date to buy shares of the company to be eligible for a bonus share issue. Anyone becoming a shareholder after the ex-date does not qualify for bonus share allotment. India follows a T+2 rolling settlement system, which means the ex-date is two days before the record date. You will have to buy the shares of a company at least a day before the ex-date to become a shareholder before the record date and become eligible for a bonus share issue.
When are bonus shares credited?
Bonus share issues play an important part in improving the liquidity for the shareholders. Like dividends, bonus share issues are intended to transfer accumulated profits to the shareholders. The benefit from dividend comes directly in the form of cash, but gains from a bonus share issue are not direct. Gains come in the form of additional shares, but what if an investor wants to offload the extra shares and receive cash. He/she will have to wait for the bonus shares to show up in the demat account to sell them. Just the announcement of a bonus share issue or being an eligible shareholder on the record date are not enough to be able to sell the shares.
With the advent of electronic mediums, instant funds transfers have become the norm. Similarly, shares are traded in their electronic or dematerialised form and hence the time required for bonus shares to be credited to the demat account has decreased substantially. Once a shareholder is identified as being eligible for a bonus share issue, a new ISIN (International Securities Identification Number) is assigned for the bonus shares. After the allotment of a new ISIN, it does not take more than 15 days for the bonus shares to be credited into the demat account of the shareholders.
Shares of companies that issue bonus shares periodically are sought after by investors seeking a regular income. Regular bonus share issues are viewed favourably by the investor community at large as the share price often rises after the issuance of bonus shares.