Earlier this month, Yes Bank shares climbed 1% on news that they would consider a stock split in their next board meeting. On July 21st, Reliance Industries Limited announced a 1:1 bonus issue in it’s 40th AGM. If you’ve been investing in stocks for any length of time, you’ve probably come across such announcements from time to time. Both of these result in existing shareholders of the company getting additional shares.
So, what is the difference between stock splits and bonus issues?
First, let’s look at what’s NOT different between the two:
- Number of Shares Outstanding: Both stock splits and bonus issues result in an increase in the number of shares outstanding
- Impact on Stock Price: Both result in the stock price being adjusted as a result of the additional shares. So no easy gains to be had
So what’s different?
When a stock splits
It’s literally that:
- The number of shares being divided further into smaller parts so that the value of the parts totals to the undivided pre-split share
- The face value of the stock comes down accordingly. e.g. a 1:1 split means face value is now half
Why? Typically to reduce the per stock price to make the stock more liquid. A stock trading at Rs 10,000 will have fewer takers than when it splits 1:10 to then trade at Rs 1,000. On the record-date, the price will officially be adjusted to reflect the new price (1/10th for a 1:10 split, 1/2 for 1:1 split and so on). Nothing else changes.
When a bonus is issued
A couple of things happen:
First, two basic Balance Sheet terms
- Share Capital: When a company lists on the stock market, it raises money by selling a certain number of shares at an IPO (Initial Public Offering) price. Share capital is the number of shares X face value (also called par value)
- Reserves: When a company IPOs, the difference between IPO price and face value X shares issued, goes into reserves. Over the years, as the company does business, the amount of net earnings not distributed as dividends is added to Reserves (i.e. money it has in reserve)
Now, when a bonus is issued:
- More shares of equal face value are created to be given to existing shareholders. This happens by using money in ‘Reserves’ thus increasing the ‘Share Capital’ (number of additional shares X Face Value)
- Since the new shares now have a fraction of the EPS (half in case of 1:1 bonus), the stock price corrects to the lower value
Why? Bonus issues are a mechanism to notionally reward shareholders. Notionally because the shareholders’ percentage ownership of the company doesn’t change, nor does the overall networth of the company.
To draw a tenuous analogy, a stock split is like dividing the same pizza into more slices while a bonus issue is like doubling the pizza by using ingredients already paid for, so that the value of the pizza + reserve ingredients stays the same
In either case, the event in isolation does not create any incremental shareholder value. Think about that the next time share prices surge when either of these events is announced.
The difference between face, book and market value of a stock – link