Bonus Issue of Shares: An In-Depth Guide for Investors

The bonus issue of shares is a great mechanism in the corporate world that benefits both companies and shareholders. It is an alternative to cash dividend payments, where investors get more shares in proportion to their existing holdings without further investment. But what is a bonus issue, and how does it affect investors? This blog will explain the concept of bonus shares, their advantages, and common FAQs.

What Is a Bonus Issue of Shares?

A bonus issue of shares, also known as a scrip issue or capitalisation issue, is when a company distributes additional shares to its existing shareholders free of charge. These new shares are issued in a ratio to the shareholders’ existing holdings, such as “two bonus shares for every five held.”

Unlike cash dividends, bonus shares are issued from the company’s undistributed reserves or retained earnings. Instead of paying out profits in cash, the company reinvests them back into equity, thus increasing the number of outstanding shares without changing the company’s market capitalization.

Why Do Companies Issue Bonus Shares?

Companies issue bonus shares for various reasons:

1. Rewarding Existing Shareholders

A bonus issue allows companies to reward their current shareholders by increasing their shareholding without them having to put in more money. This is often seen as a goodwill gesture to retain loyalty.

2. Improving Liquidity

By increasing the number of shares in the market, bonus issues can increase trading activity. With more shares out there, share prices may become more affordable for retail investors and this improves liquidity.

3. Retaining Cash Reserves

Instead of distributing profits as cash dividends, companies can use accumulated profits to issue bonus shares, which keeps cash for future use.

4. Enhancing Perception

A bonus issue can create a good image of the company and shows confidence in future profitability. It means the company has sufficient profits or reserves to justify such an issue.

Advantages of Issuing Bonus Shares

1. Increases Investor Confidence

Issuing bonus shares shows a company is in good financial health. This boosts investor confidence.

2. No Immediate Tax Liability

For UK investors, bonus shares are generally not taxed as income. They are only taxed for capital gains tax (CGT) purposes when sold. That is a deferred tax advantage.

3. Improves Shareholding Value Over Time

Although the share price may drop post-issue due to the increased number of shares, the overall value of an investor’s holdings remains the same. Over time, the company’s growth can enhance the value of these extra shares.

4. Attracts Retail Investors

Lower share prices after a bonus issue makes the stock more attractive to retail investors, and increases demand and liquidity.

5. Demonstrates Strong Reserves

A bonus issue shows the company can use its retained earnings, which means the company’s balance sheet is strong.

Bonus Shares vs. Other Corporate Actions

1. Difference Between a Bonus Issue and a Rights Issue

• Bonus Issue: Free shares are issued to existing shareholders in proportion to their holdings, using retained profits or reserves.
• Rights Issue: Shareholders are offered new shares to buy at a discounted price, often to raise fresh capital for the company.

2. Difference Between a Bonus Issue and a Stock Split

• Bonus Issue: Distributes additional shares to shareholders, increasing the number of shares outstanding but leaving the company’s market capitalization unchanged.
• Stock Split: Divides existing shares into smaller units, reducing the share price proportionally but keeping the total value of holdings the same.

How Bonus Issues Affect Shareholders

1. Share Price Adjustment

After a bonus issue, the share price usually goes down in proportion to the number of shares issued. For example, if a stock trades at £100 and a 1:1 bonus issue is announced, the share price may adjust to £50 after the issue.

2. Increased Holdings

Shareholders get more shares, though the total value of their investment doesn’t change initially.

3. Dividend Implications

Future dividend payments may be diluted as the total number of shares increases, and the company’s profits are spread over a larger base.

FAQs About Bonus Issues

How Are Bonus Shares Taxed in the UK?

In the UK, bonus shares are not taxed when issued. But they are counted for capital gains tax (CGT) purposes when sold. The acquisition cost for CGT purposes is adjusted based on the original purchase price of the shares and the bonus issue ratio.

Is a Bonus Issue Good for Investors?

Yes, a bonus issue of shares can be beneficial for investors. It increases their shareholding without requiring them to invest more. But the immediate financial gain is limited, as the share price adjusts accordingly.

Can I Sell Bonus Shares Immediately?

Yes, you can sell bonus shares as soon as they are credited to your account. But think of market conditions and tax implications first.

Related posts on Penny Stocks UK:

A Beginner’s Guide to Investing into UK Stock Market Getting Started in the UK Stock Market for Beginners Consider Buying UK Penny Stocks? Learn These 6 Terms First Should You Use the Practice Account in Penny Stock Trading?