Samin Gurung, Sharesansar Media Officer, contributed to this article.
After only a short period of time, an amateur investor dabbling in the secondary market becomes overwhelmed by the buzz of bonus dividend announcements and the excitement that arises among investor circles.
It is thus embedded in the conversation that a bonus dividend declaration is a positive development for the company and its shareholders, and that the larger the proportion of the dividend declared, the better for both.
However, there are a number of aspects of the bonus dividend announcement that make it difficult for an inexperienced investor to see the broad picture and connect the various dots. The fact that even experienced investors have misread it in part just adds to the difficulty of the situation. In this regard, this article is written for the novice investor who has recently entered the secondary market, perhaps during the bull market that began a year earlier. This essay, on the other hand, can be used by experienced investors to compare their own understanding of the subject and to determine whether or not they have everything correct.
1) The first item is intended to cover the fundamentals.
To begin with, a bonus share declaration is a method for corporations to compensate their shareholders for their investment. Companies may elect to pay a portion of their profits to shareholders in the form of cash dividends. However, there are restrictions on how much cash can be distributed by a firm. Furthermore, from the perspective of value investment, it is acknowledged that a firm that decides to share all of its profits in cash is a corporation that does not know what to do with its money. According to common sense, a company’s profits should be re-invested in order to grow larger, better, and more efficient.
When it comes to bonus shares, here is where the notion comes into play. It is possible for a firm to pay back its shareholders without giving them a cash deposit. Bonus shares are distributed in this manner. Suppose a firm decides to distribute bonus shares worth 20% of its total shares, meaning that a shareholder will have 20% more shares after the bonus declaration than he had when he purchased the shares originally.
If an investor owned 100 shares before to the proclamation of a 20 percent bonus, he will now have 120 shares in total after the bonus distribution is made available.
There isn’t much of a focus in this article on the complete procedure and timetable for bonus share distribution. The answers to such questions may be found here and here for those who need to educate themselves on the subject first.
Things, on the other hand, are not so straightforward and straightforward. An investor will not be able to sell his 120 shares at the same price at which he sold his first 100 shares. In other words, an investor isn’t instantly rewarded with profits equal to 20 times the value of his or her stock. This is due to the fact that these bonus shares will have to be offered at a discounted price, which will result in a decrease in the stock price of the company. All of this will be detailed in further detail in the next sections.
2) The issuance of Bonus shares is regarded as a type of financial deception.
The reader may be perplexed by the first point: if the corporation chose not to pay any cash and instead elected to distribute bonus shares, where did the actual amount of profit that the company earned go?
Simply said, a company’s retained earnings are used to pay dividends (cash and bonus) to its shareholders and employees. Rather than distributing bonus cash, bonus shares are issued instead, and the amount of the bonus issue is simply transferred from the retained earnings account to the share capital and share premium account.
As a result, upon closer inspection, it becomes apparent that the cash is only theoretically transferred from Fund A (retained earnings) to Fund B. (share capital). The number of assets owned by the corporation remains the same as it was previously. Would it make you richer if you took a Rs 1000 note from your left pocket and put it in your right pocket and repeated the process?
Note from the author: The scenario above is presented in a straightforward manner to facilitate learning; however, bonus declaration is not truly a zero-sum game because a corporation gains by raising its share capital and reinvesting its profits.
3) The issuance of bonus shares results in an increase in the company’s share capital.
As previously stated, bonus share distribution does have the effect of increasing a company’s share capital in the short term. According to Investopedia, this leads the company to be regarded as being larger than it actually is, so increasing its attractiveness to prospective investors.
A firm with a larger share capital is regarded with adoration and respect by its clients and investors, as the share capital is, after all, the key indicator of the company’s size, reliability, and trustworthiness.
4) The issuance of bonus shares causes an adjustment in the stock price of a corporation.
Bonus shares, as briefly discussed in the previous points, cause a decrease in the stock price of a company on the day they are listed on the stock exchange. However, this is not a coincidental decline. There is a fundamental principle that must be adhered to.
A company’s market capitalization does not change as a result of bonus shares being issued.
This is the principle that was mentioned in the previous paragraph. During a bonus share listing, the stock price of a firm is adjusted in such a way that the addition of the additional number of shares has no effect on the company’s market capitalization.
Consider the following scenario: A corporation has 50 shares in the market, each of which is worth Rs. 100. As a result, the company’s market capitalization (which is equal to the market price multiplied by the number of shares) is Rs. 50, 000. Afterwards, the business distributes 100 percent bonus shares, bringing the total number of shares in circulation to 100 percent. Now, in order to maintain the same market capitalization on listing day, the share price has been cut to Rs. 50 per share, resulting in the following:
50 shares before bonus * Rs. 100 = 100 shares after bonus * Rs. 50 shares before bonus * Rs. 100
Readers can use Sharesansar’s automatic Bonus Share Adjustment Calculator to figure out how much their shares will increase in value following the bonus listing.
6) Bonus shares do not dilute an investor’s stock ownership in the company.
A bonus declaration is completed in a proportional manner. In the event of a 20% bonus share declaration, an investor holding 10 shares will receive 2 additional shares, while an investor holding 100 shares of the corporation will receive 20 additional shares. Because every shareholder’s stock in the company has increased in value by the same proportion, each shareholder still owns the same percentage of the company as he did before. Consequently, no change has occurred in the percentage of ownership in the company.
7) The value of an investor’s investment remains constant, both before and after the bonus adjustment is made.
Following the bonus adjustment, an investor is left with more shares but at a reduced per-share price, allowing him to maintain the same total value of his portfolio. If an investor does not pay attention, he will not be aware of the bonus listing day because his portfolio will not be suddenly reduced or boosted as a result of this.
Following the bonus listing, the stock is traded, and the shift in stock price that results is a result of supply and demand pressures, just as it would be on any other day.
Note: It is widely thought in the Nepalese financial community that the stock will suffer a loss on the day of adjustment. This is due to the fact that bonus shares are adjusted on the date of book closing. Since shareholders who have held their shares prior to the book closure date are eligible for the dividend payout, many believe that shareholders who have held their shares prior to the book closure date will prefer to sell on the book closure day because they are already eligible for the dividend. However, no extensive research has been conducted on this subject, and confirmation in a small number of cases is insufficient to draw a judgment from the evidence.
Eighth, the biggest advantage is that an investor is left with more shares without having the par value of his or her investment diminished.
One item that remains constant for the company’s stock in the midst of all of the modifications and revisions is the par value, which remains at $1 per share. The par value for the majority of enterprises in Nepal is Rs. 100. The par value of a firm remains constant regardless of how much its stock market price fluctuates on a daily basis. Following the bonus adjustment, the par value is retained. If an investor buys more shares at a lower market price than previously, he or she can console themselves by reasoning that they now own more shares of the company with the same per-unit par value as before when they bought a lot more shares at a higher market price.
9) Stock price adjustment following the issuance of bonus shares may result in increased liquidity.
Interestingly, a bonus declaration is remarkably similar to a stock split in this sense. A stock split increases the number of shares in a firm by lowering the price of each unit of stock in the company. As a result, an investor’s investment retains its original worth, with the exception that he now owns more shares at a reduced price due to the increase in the number of shares he owns.
In this case, the advantage of a stock split or a bonus announcement is that it makes the stock more inexpensive for investors because each share is less expensive than before. Furthermore, existing shareholders may opt to easily trade their shares if they require cash in the future, if they so desire. This contributes to the improvement of a stock’s liquidity.
10) A large number of investors in Nepal expect that the price would rise to the prior level following the bonus adjustment.
In Nepal, there are various gray areas when it comes to bonus declaration.
A company’s stock price may rise before a large dividend payment is announced publicly, indicating that insider information has been leaked. Aside from that, anonymous social media personas declare dividends before the company does, and seemingly sensible investors follow their lead.
While the burden of policing such wrongdoings falls to the regulator, there is a widespread belief in the Nepalese market that has evolved into an unwritten law as a result of this assumption. Nepalese investors believe that the price of a firm will rise back to its original level after a bonus adjustment has been made, sometimes over a period of several business days. They believe it occurs as a result of investor psychology, as investors have already witnessed the price at a greater level.
There is, however, no basis for the price to climb and reach this level, except from the evident benefits of the bonus declaration and its underlying essence (reinvestment of earnings). Stocks tend to rise in value over the long run, and the author feels that the probability of the stock price reaching this level is the same as the probability of the stock price reaching any other position on the chart.
Gurung works as a media officer at Sharesansar, where he spends the most of his office hours assessing article submissions, producing news content, and occasionally conducting interviews with the directors of some of Nepal’s most innovative enterprises. He keeps a personal investment journal at nepalearn.com, which you can find here.
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