In investing, the different terms and concepts can sometimes be confusing for beginners. One such term is “bonus share.” If you are new to the stock market or want to expand your knowledge, this article will clearly explain what bonus shares are and how they work.
What are Bonus Shares?
Bonus shares, scrip dividends, or capitalization issues, refer to additional shares that a company offers to its existing shareholders at no charge. Such shares are given to the shareholders based on their current shareholding. For example, if you currently hold 100 shares of a company and they announce a 1:1 bonus issue, you will get an additional 100 shares free.
The purpose of issuing bonus shares is to reward existing shareholders and increase the liquidity of the company’s stock. By issuing bonus shares, the company effectively splits its existing shares into a larger number of shares, but the total value of the shareholders’ stake remains the same.
Why Do Companies Issue Bonus Shares?
Companies issue bonus shares for several reasons:
- Retained Earnings: A common reason is to use the company’s retained earnings. Instead of distributing these earnings as cash dividends, the company converts them into bonus shares, allowing shareholders to benefit from the company’s success.
- Increasing Liquidity: Issuing bonus shares increases the number of shares available in the market, which can increase the liquidity of a company’s stock. This increased liquidity could attract more investors and potentially improve the trading volume of the company’s shares.
- Share Price Adjustment: Companies may issue bonus shares to adjust their share price. If the share price has become too high, issuing bonus shares can lower the price per share, making it more affordable for retail investors.
- Improving Market Perception: Bonus issues are often viewed by investors as a positive sign, indicating that the company is performing well and is confident about its prospects. This could increase investor confidence and potentially drive the share price higher.
How Do Bonus Shares Impact Investors?
When bonus shares are issued, the number of shares held by investors increases, but the proportional ownership remains the same. This means that the value of the investment does not change immediately. However, bonus shares can have several long-term effects:
- Increased Dividend Income: As the number of shares investors own increases, so does the potential dividend income. If the company continues to perform well and pay regular dividends, investors will receive larger dividend payments.
- Improved Market Perception: Bonus issues are often viewed positively by the market, which can lead to increased demand for a company’s shares. This increased demand can drive up the share price, resulting in capital gains for investors.
- Enhanced Portfolio Diversification: Bonus issues can provide investors with additional shares, allowing for better diversification within their investment portfolio. This diversification can help reduce risk and potentially improve overall returns.
Conclusion
Any investor in the stock market needs to understand bonus shares. By issuing bonus shares, companies reward their existing shareholders, increase liquidity, adjust share prices, and improve market sentiment. For investors, bonus shares can increase dividend income, improve market sentiment, and increase portfolio diversification. Remember that although bonus shares may not have an immediate impact on the value of your investment, they can have long-term effects that can benefit your overall investment strategy.
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