Bonus Issue

Bonus Issue (also known as a 'Scrip Issue' or 'Capitalization Issue') is when a company distributes free, additional shares to its existing shareholders, in proportion to their current holdings. Think of it like this: you own a whole pizza, and you decide to cut it into 12 slices instead of 8. You have more slices, but the total amount of pizza hasn't changed one bit. Similarly, a bonus issue increases the number of a company's shares in circulation, but it does not change the company's overall value or the total value of your investment. Why? Because the share price will adjust downwards to reflect the new, larger number of shares. At its core, a bonus issue is an accounting maneuver where a company converts its accumulated profits, held in its reserves, into new share capital. It’s a way to reward shareholders without paying out cash, essentially acknowledging the company's growth on paper.

The process is straightforward. A company's board will announce a bonus ratio, such as 1-for-2 or 1-for-5. This ratio determines how many new shares an investor will receive. For example, let's say you own 200 shares in “Pizza Co.”, and the stock is trading at $30 per share. Your total investment is worth 200 x $30 = $6,000. Pizza Co. then announces a 1-for-2 bonus issue. This means for every 2 shares you own, you get 1 free share.

• Calculation: You own 200 shares, so you will receive (200 / 2) x 1 = 100 new shares.
• New Total: You now own 200 + 100 = 300 shares.
• Price Adjustment: The company's value hasn't changed, so the market will adjust the share price. The new theoretical price will be $6,000 / 300 shares = $20 per share.

Your total holding is still worth $6,000, but it's now represented by more shares at a lower price. This effect is very similar to a stock split, where a share is divided into smaller pieces. The main difference is in the accounting: a bonus issue shifts value from reserves to capital, while a stock split simply changes the par value of shares without touching the reserve accounts. For an investor, the practical outcome is nearly identical.

If it doesn't create new value, why bother? Companies have several strategic reasons for issuing bonus shares.

• To Increase Liquidity: A very high share price (e.g., over $1,000) can discourage small retail investors. By issuing bonus shares and lowering the price per share, the stock becomes more accessible and affordable to a wider audience. This can increase trading volume and improve the stock's overall liquidity.
• As a Signal of Confidence: A bonus issue can be a strong, positive signal from management. It implies that the board is confident in the company's future financial health and its ability to generate profits to support a larger equity base. The message is: “We expect future earnings to be strong enough that your earnings per share (EPS) won't be permanently hurt by these extra shares.”
• To Reward Shareholders Without Using Cash: If a company is profitable but needs to conserve cash for expansion, debt repayment, or R&D, a bonus issue is a clever way to reward shareholders. It acknowledges the company's success and gives investors something tangible (more shares) without impacting its cash position, which is a key difference from paying cash dividends.
• To Capitalize Reserves: A company with a long history of profitability might have massive accumulated reserves on its balance sheet. A bonus issue formally converts a portion of these paper profits into permanent share capital, reflecting the company's long-term growth in a more structured way.

While a bonus announcement might cause a short-term price pop from excited investors who think they're getting something for nothing, a savvy value investing practitioner looks much deeper. A bonus issue, in and of itself, creates zero economic value. The company is the same size, has the same assets, and the same earning power as it did the day before. Your percentage ownership of that company also remains exactly the same. It's financial window dressing. The real question isn't if a company issued a bonus, but why. Is it backed by a decade of strong, sustainable earnings and a bright future? Or is it a gimmick to distract from a struggling business and create a temporary illusion of momentum?

A bonus issue is only meaningful if the underlying business is sound. Before you celebrate, do your homework and check the fundamentals:

• Consistent Profitability: Has the company been consistently profitable? The reserves being capitalized should come from real, earned profits, not from one-off accounting tricks or asset revaluations.
• Return on Equity (ROE): A great company doesn't just earn profits; it reinvests them at a high rate of return. If the company is simply capitalizing reserves without a clear plan to grow future profits, the bonus is an empty gesture. A master capital allocator like Warren Buffett would argue that retaining earnings to reinvest at a high return on equity (ROE) is far more valuable to shareholders than any bonus issue or dividend.
• The Big Picture: Never forget the core principle: you are buying a piece of a business, not a lottery ticket. The number of shares is just a unit of account. Your focus should always be on the company's long-term competitive advantages, the quality of its management, and its intrinsic value. If a fantastic company trading below its intrinsic value announces a bonus issue, that’s a nice footnote. But the bonus itself should never be the reason you invest.