Discussion Topic: Stock Split vs Bonus Issue
Today, we will compare two important terms of stock trading, i.e. - stock split vs bonus issue. Though the workings of these two terms are nearly similar, they are quite different from each other. So, we have decided to write an article on the difference between Stock Split and Bonus Issue.
Introduction to Stock Split and Bonus Shares
Stock split and bonus issue are two commonly practiced corporate actions (an event that affects the shareholders) by companies to increase the number of outstanding shares. The key difference between stock split and bonus issue is that stock split is referred to as dividing company’s shares into multiple ones to improve affordability, whereas bonus issue is the means of offering free shares to the existing shareholders.
Before learning the differences between Stock Split vs Bonus Issue, let us first learn something more about both stock split and bonus issue.
What is Stock Split?
A Stock Split is an accounting practice where a company divides its existing shares into multiple shares. Think of it as exchanging a $20 currency note for two $10 currency notes. For example, if you are holding 100 shares of Company X at $100 per share and stock gets split by 2:1, which means your 1 stock share becomes 2 now, so the total number of shares will be 200 but the price will become half i.e Rs $50 (per share).
Normally, a company’s management considers a stock split when they want to increase the liquidity of shares. It is also undertaken to reduce the share price when the market price of a stock becomes too much expensive for smaller investors. The company decides to split the shares to bring down the share price.
After completion of a stock split, the number of shares you hold will increase but the value of your investment will remain the same. Both the market price and face value of that stock will be decreased based on the stock split ratio.
Considering the same example we referred above, if the face value of that stock was $10 before the split, it will become $5 after a 2:1 stock split.
A decision for a stock split can be taken either by the board of directors or by the vote of shareholders; hence, this can be both time-consuming and expensive exercise.
If you want to know more about the stock split, read our guide on what is a stock split? - Meaning, advantage, and disadvantage.
The opposite of stock split is denoted as a ‘Reverse Stock Split’ where existing shares are merged to reduce the number of outstanding shares and increase the share price. See our guide on What and Why of Reverse Stock Split.
What is Bonus Issue?
Bonus Issue is thought to be an alternative to paying cash dividends. If for any reason the company doesn't want to dispense cash out of the fund but at the same time they don't want to dissatisfy their shareholders, they take the way to issue bonus shares. This can reduce the dissatisfaction as the shareholders can sell those bonus shares to get immediate cash.
Bonus Shares are also widely known as ‘scrip shares’ and the distribution procedure is known as bonus issue. These shares are issued to the existing shareholders for free according to the pre-decided proportion to their holdings.
For example, If Company X announced a bonus issue of 1:2 that means a shareholder will receive 1 additional share for every 2 shares he holds. So if you were holding 100 shares of Company X then your net holding will become 150 shares. Moreover, these additional shares are issued for free, you don't have to pay anything to receive these shares.
But the big difference between bonus issue and stock split is that in bonus issue the face value of stock remains unchanged.
If you want to know more about bonus issue, read our guide on what is bonus issue of shares? - Meaning, advantage, and disadvantage.
Effects of Stock Split and Bonus Issue on Stock Market
The best way to understand the difference between Stock Split and Bonus Issue is to understand their effects on the stock market or on the share price.
Let’s assume you own 200 shares of Company A which has a market value of $100 per share, and a face value of $10 per share. Now we will see the effect on your stock holding when a company announces 1:1 bonus issue and 2:1 stock split.
After 1:1 Bonus Issue:
Your total share count will be 200+200(bonus) = 400
The market value of stock will be = $50 per share [i.e. - ($100 * 200)/400].
Face value will remain $10 per-share as bonus issue does not affect face value.
After 2:1 Stock Split:
Your total share count will be 200*2 = 400
The market value of stock will be = $50 per share [i.e. - ($100*1)/2]
Face value will become $5 per-share [i.e. - ($10*1)/2]
Difference Between Stock Split and Bonus Issue (Comparison)
|BASIS FOR COMPARISON||STOCK SPLIT||BONUS ISSUE|
|Meaning||Stock Split is referred to as dividing company’s shares into multiple ones to increase the affordability.||Bonus shares are shares issued by the company to their existing shareholders for free. It is issued in the proportion of their existing holdings.|
|Objective||Distribute profit without paying dividends||Gain market position or saving the brand value|
|Availability||Both existing shareholders and potential investors can benefit from the stock split.||Bonus Shares are only available to the existing shareholders.|
|Cash Flow||No Additional Cash Flow||No Additional Cash Flow|
|Face-Value||Face value of stock changed||Face value of stock remain unchanged|
|Goals||To bring the market price per share, within a more popular range.||To bring the market price per share, within a more popular range.|
Stock Split vs Bonus Issue: Final Thoughts
Both bonus issue and stock split result in a reduction in the market price of shares and an increase in the total number of outstanding shares. The main difference between stock split and bonus issue depends on whether or not cash consideration is received. These two options should be exercised carefully as the reduction in share price (and face value) may impose a negative impact on the market trend.
If you are an investor in the company, you have reason to cheer when you get bonus shares. Because giving out bonus share usually means that the company is in a profit-making zone. But don’t celebrate when your company exercises a stock split. It’s is just a tactical way to alter the market value and face value of a stock. But if you are sure about the fundamentals of the company, then these are good times to buy them as you will get them at a cheaper price.
To learn more, check out our guide on fundamental analysis.
We hope that you have enjoyed the above article describing the Stock Split vs Bonus Issue of shares. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions or doubts about the difference between stock split and bonus shares. Also, let us know if you have received and rights issue or bonus from any company in recent past.