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Shares on the house

Rahul Oberoi        Print Edition: Dec 25, 2011

A bonus is always welcome. So is a bonus share issue . Giving bonus shares is one of the ways companies reward investors without disturbing their cash balances. "One way of rewarding shareholders is to give dividends. Another is by giving bonus shares and capitalising reserves," says Sanjiv Bajaj, Managing Director, Bajaj Capital.

Does a bonus issue benefi ts investors? Data collected over a 10-year period shows that in most cases, the stock price of a company rises after a bonus issue. Our analysis is split into two parts: first, the movement in share price from the time the issue is announced till the record date - the date by which the company fi nalises the list of those eligible for bonus shares; and second, one year after the record date.

Of the top 30 companies, which announced bonus issues between January 2001 and July 2010, the share prices of 21 had risen by the record date.

What are bonus shares
Bonus shares are shares given away to existing stockholders in proportion to the number of shares they hold. A 1:1 bonus means that a shareholder gets one share for each share held by him, without paying anything extra. If someone holds 10 shares, he gets 10 more. A 2:1 bonus means he gets twice as many shares as he already possesses. However, after the bonus issue, the share price of the company usually gets adjusted according to the bonus ratio. For example, if the price before bonus is Rs 200 and a company issues bonus shares in the ratio of 1:1, the post-bonus share price will be Rs 100, which means that the total market value (2 x Rs 100 = Rs 200) remains the same.

To give bonus shares to investors, companies build reserves by retaining a part of their profi t over the years - the part that is not paid as dividend. When these reserves increase, they transfer a part of the money into the capital account, from which they issue bonus shares. Only fully paid-up shares are eligible for bonus. "The purpose of issuing bonus shares is to increase liquidity in the stock and hand out the available distributable net worth in a cash-neutral manner," says Sudip Bandyopadhyay, Managing Director and CEO, Destimoney Securities.

Added Bonanza
You get bonus shares only if you have shares in your demat account on the record date

To take just three examples, during a one year period from the record date after they issued bonus shares, the adjusted stock price of Mahindra & Mahindra surged 82 per cent to Rs 330; that of Tata Consultancy Services by 79 per cent to Rs 775; and that of Larsen & Toubro by 71 per cent to Rs 1,654. In contrast, however, a few companies like HCL Technologies, Reliance Industries and Dabur India lost value in the year that followed a bonus share issue.

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Impact on price

Mehul Ashar, President-head, Wealth Management, Inventure Growth and Securities, says: "A bonus issue is generally perceived to be positive by investors and creates more demand for the stock. If in the following year, the company increases its earnings and maintains the earning per share at levels estimated by the management, the stock will give good returns."

After the bonus issue, the number of shares outstanding increases (in the same ratio the bonus shares were issued), and the earning per share, or EPS, falls to the same extent. "Mostly, healthy companies go for bonus issues. There is a high chance of the stock price rising in the couple of quarters after the record date." says Prakash Diwan, Head-Institutional Clients group, Asit C. Mehta Investment.

The most common reason for issuing bonus shares is that the share price has become high and is affecting demand. "A company issues bonus shares when it has bright prospects and does not mind diluting capital," says Kaushik Dani, headequity, Peerless MF. "It increases liquidity and retail participation."

Not all are lucky
Then why did the companies whose share prices suffered after a bonus issue not follow the same trend? Alex Mathews, Research Head, Geojit BNP Paribas Financial Services, disagrees with the general view that bonus issues do all companies good. "The announcement of bonus shares has no affect on share price," he says. "After the announcement, the stock can move in either direction depending on market sentiment." Pankaj Pandey, Head, Research, ICICI Direct, feels the same. "Market sentiments give direction to stocks. However, bonus shares help increase liquidity in the stock," he says.

But they are the exceptions. Recently, Ashok Leyland, Titan Industries and Bhuwalka Steel Industries offered bonus shares to investors, resulting in a rise in prices, the prices spiking around two, nine and 10 per cent, respectively. However, if you plan to buy shares of a company just because it is going to announce a bonus issue, hold on.

Shares should never be bought purely on the basis of expected bonus shares. The fundamentals of the company should fi rst be ascertained. "A bonus issue is a sign the company is expanding equity and increasing liquidity, but it is not the only indicator of performance," says Rajesh Jain, Executive Vice President and Head of Retail Research, Religare Securities, "Investors should take a decision after analysing the fundamentals."

Kaushik Dani of Peerless MF agrees. "Bonus shares lead to adjustment in the share price according to the proportion of dilution," he says. "So, the price may come down in the immediate term. However, in the long run, the share price depends on the fundamentals and growth prospects of the company." You should always study the company before taking a call on investing in one that has announced or is considering issuing bonus shares, or walk across to an advisor to know more.

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