Bonus Issues

A Bonus Issue (also known as a 'Scrip Issue' or 'Capitalization Issue') is when a company distributes new, free shares to its existing shareholders, in proportion to their current holdings. Think of it as a reward from the company, but one that comes from its own pockets. Essentially, the company converts its accumulated profits, known as retained earnings, into new share capital. For instance, in a '1 for 4' bonus issue, an investor receives one extra share for every four they already own. While this increases the total number of shares in circulation, it's crucial to understand that it doesn't change the company's overall value. The company's market capitalization remains the same; the value is just spread across more shares. This is the classic “cutting a pizza into more slices” analogy: you have more slices, but the size of the pizza hasn't changed. Each slice (or share) is simply smaller (worth less).

The mechanics of a bonus issue are a pure accounting maneuver. A company builds up profits over time that it doesn't pay out as dividends. These are held on the balance sheet in an account called 'retained earnings' or 'reserves'. When a bonus issue is declared, the company moves a portion of these funds from the reserves account to the 'share capital' account. This transfer justifies the creation of new shares, which are then distributed to shareholders for free. Let's use a simple example:

• You own 100 shares of 'Pizza Co.', and each share is trading at $20. Your total holding is worth 100 x $20 = $2,000.
• Pizza Co. announces a 1:1 bonus issue. This means for every one share you own, you get one free share.
• You now own 200 shares (your original 100 + 100 bonus shares).
• Has your wealth doubled? No.
• The total value of Pizza Co. hasn't changed, but the number of shares has doubled. Therefore, the share price will theoretically adjust downwards by half.
• The new share price will be around $10 ($20 / 2). Your total holding is now 200 x $10 = $2,000.

The value of your investment is exactly the same as it was before the bonus issue.

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

A high share price can sometimes deter smaller retail investors. For example, a stock trading at $1,000 per share might seem 'expensive' or inaccessible. By issuing bonus shares, the company lowers the price per share, making it psychologically more appealing and affordable for a wider range of investors. This can increase the number of transactions and improve the stock's trading liquidity.

A bonus issue is often interpreted as a positive signal from management. It suggests that the company's leaders are confident they can generate sufficient future earnings to service a larger equity base (i.e., pay dividends on more shares). It can be a subtle way of saying, “We've been profitable, we expect to remain profitable, and we want to reward our long-term shareholders.”

Sometimes, a growing company wants to reward shareholders but needs to conserve cash for reinvestment into the business—for new projects, expansion, or paying down debt. A bonus issue is a way to provide a return to shareholders without a cash outlay. In some countries, this can also be more tax-efficient for the shareholder than receiving cash dividends, though you should always consult a local tax advisor.

For a value investing practitioner, a bonus issue is an event to be analyzed, not celebrated. It is, in and of itself, a non-event in terms of value creation. Your ownership percentage in the company remains unchanged, and the company’s intrinsic value is not affected one bit.

Never mistake a bonus issue for a gift of free money. It's an accounting transaction, not an economic one. The critical questions are not if the company issued a bonus, but why and how.

• The 'Why': Is this a signal of genuine confidence from a financially sound company with strong growth prospects? Or is it a gimmick from a struggling company trying to create a positive news cycle and artificially support a flagging share price?
• The 'How': Is the bonus funded by a long history of robust, retained profits? A company that consistently generates cash and periodically capitalizes it into bonus shares is demonstrating discipline and a shareholder-friendly attitude.

Bonus issues and stock splits achieve a similar outcome: more shares at a lower price. However, they are different from an accounting standpoint.

• Bonus Issue: A formal capitalization of profits. Money is moved from the 'reserves' account to the 'share capital' account. The par value of the share typically remains the same.
• Stock Split: A simpler division of the existing shares. No funds are moved. The company simply splits each existing share into multiple new ones, which reduces the par value per share.

A bonus issue is a neutral event. It doesn't make a good company great or a bad company good. Your job as an investor is to look past the “bonus” and focus on the fundamentals. Treat it as a piece of the puzzle—a signal from management that must be verified by digging into the company's long-term performance, profitability, and financial health. A history of bonus issues from a high-quality business can be a wonderful sign of a long-term compounder. But remember, it's the healthy pizza, not the number of slices, that truly matters.