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View: Stock split and bonus as different from each other as chalk from cheese

There is a misconception in many quarters that stock split and bonus shares are the same. Both vest a shareholder with more shares but there ends the similarity.

By S Murlidharan  April 19, 2022, 7:50:57 AM IST (Published)

Tata Steel whose face value per equity share is Rs 10 was quoted at Rs 1,316 on April 13, 2022. Its fortunes in the market have been on the ascendance and hence its Board is going to mull a stock split in the first week of May 2022 lest it becomes out of reach for investors with limited means. The stock split is not new nor is its mistaken cousin bonus issue new in India. The article, however, is not about specific companies that have resorted to a stock split or bonus but a primer to disabuse the notion that they are the same, an impression fostered by the US analysts in their attempts to run down bonus issues as an illusory reward to shareholders. The truth is stock split and bonus are as different from each other as chalk is from cheese.

When a bonus issue is made by a company say in the ratio of 1:1 when its share capital was Rs 2 crore (20 lakh shares with a face value of Rs 10 each) and its free reserves were Rs 10 crore, a person holding 100 shares would in its wake become the holder of 200 shares without having to pay a single rupee for the additional shares. Its balance sheet in the wake of this exercise would undergo a significant change—its share capital would now stand at Rs 4 crore but its free reserves would stand reduced to Rs 8 crore, leaving the net worth of the company—share capital plus reserves—where it was Rs 12 crore.

Had this company instead gone for a stock by reducing the face value of shares to Rs 5 each, the bottom line superficially would be the same—the shareholder in the example would after the split hold 200 shares and the company’s capital, free reserves and their aggregate i.e., net worth would remain unaltered at Rs 2 crore 40 lakh shares of Rs 5 each), Rs 10 crore and Rs 12 crore respectively.

What stands out to distinguish the bonus from the stock split is the dramatic change in the composition of net worth—share capital in the above example increasing by Rs 2 crore to Rs 4 crore with a corresponding reduction in free reserves from Rs 10 crore to Rs 8 crore. It is amazing that this vital distinguishing feature has been lost on those who flippantly shrug off a bonus issue as nothing but a stock split.

Post bonus the shareholder on hand would hold 200 shares of Rs 10 each face value whereas post-split, he would own 200 shares all right but each with a face value of Rs 5 each. What it spells in practical terms is should the company continue with the same cash dividend rate of say 100 percent, post-bonus, the dividend would double from Rs 1,000 to Rs 2,000. But had it been split instead of a bonus, the dividend would remain the same for him Rs 1,000.

The bottom line is bonus is a statement of confidence by a company as to its future and is potentially more regarding to the shareholders. The market too takes the cue and post-bonus quotations reflect this reality. To wit, if the pre bonus price was Rs 1,000 post bonus (1:1) quotation may be Rs 600 in a normal market and might maintain a rising trend if the company does plough back the profits retained by it successfully for expansion or diversification.

That is why a company has to think many times over before announcing a bonus because it is sticking its neck out—it has business opportunities that is going to increase its profits so that the company can either maintain the same rate of dividend or better still better it with a hike. But then should the company’s confidence not been borne out by future events, its bonus issue would attract flak as nothing but a stock split especially should it be constrained to halve its dividend rate to 50 percent in the face of profits stagnating at the same level.

Is stock split just a cosmetic exercise? The answer is no. What the company is trying is doing its bit to help its shares become affordable in the market. Tata Steel might possibly quote at Rs 140 assuming its Rs 10 shares are split into ten shares of rupee 1 each. In the milieu of dematerialised shares where the market lot is just a single share, one can invest just Rs 140 if he is enamored of Tata Steel whereas he would have been left pining for it earlier when the price of Rs 1,316 per share was beyond his reach. Bonus on the other hand is an option only for companies that can use the accumulated profits to produce greater profits for the shareholders.

The bonus also presages a company going public. A hefty bonus issue is an attempt by the existing shareholders to shut out the newcomers in IPO from laying claim to past profits to which they had not contributed.
— S. Murlidharan is a CA by qualification and writes on economic issues, fiscal and commercial laws. The views expressed in the article are his own.


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