India’s economy is in the pink of health. The financial year 2005-06, saw it grow by 8.1 per cent. India Inc. has witnessed a similar growth.The Sensex, during the same time period, delivered a return of 70.78 per cent.This has led to several companies making ‘bonus issues’ and ‘stock split’ announcements. The calendar year 2005, witnessed 210 stock splits and 94 bonus issues. The current year (i.e. till May 5, 2006), has already observed 26 bonus issues and 46 stock splits.
READING INTO BONUS ISSUES
A bonus issue is the issue of additional equity shares by a company to its existing equity shareholders, at no cost to the shareholder. These shares are proportionately distributed in ratios, like 1:1 or 2:1, symbolising the proportion of your share holding and the bonus due to you.
RATIONALE FOR BONUS ISSUES
Reward Shareholders: The managements of profit-making companies opine that allotting bonus shares to shareholders is a method of distributing the profits to the shareholders as a reward for their belief in the company. Attract
Investments: A bonus issue sends a signal to the market that the company has been performing well and is confident that it can maintain its level of profitability in the future.
Peer Pressure: A company may feel pressured to announce a bonus issue if its competitor announces one.
GETTING A GRIP ON STOCK SPLITS
In a stock split, the face value of the existing shares is reduced in order to create fresh equity. There is no new equity issued.
RATIONALE FOR STOCK SPLITS
To change investor perceptions: There is a tendency for investors to consider a ‘high priced’ stock as expensive. Accordingly, companies whose share prices have risen to very high levels usually resort to stock splits, to artificially reduce their share price and attract a larger number of investors and thereby increase the liquidity of the stock. This corporate action will also make the company appear more attractively priced vis-à-vis its peers.
ELIGIBILITY
To be eligible for either of the two above-mentioned corporate actions, your name must appear in the company’s book on the ‘record date’. The record date is the date beyond which if your name appears in the company’s book, you will not be the beneficiary of the corporate action.
IMPACT OF THE ACTION
On the company’s share price: Immediately after the announcement of a bonus issue or a stock split, generally the share price increases. This rise is more pronounced in the case of a bonus issue than a stock split. Theoretically, after the record date, the price will fall to the extent of the ratio of the bonus issue or the stock split. However, in most cases, it has been observed that the fall is much less.This is because the share price depends on market sentiments, economic factors and the demand/ supply of the stock.
On retail investors: Investors can take advantage of the upward trend that a stock price witnesses when an announcement of a bonus issue or a stock split is made. When the share price falls after the record date,the investors will enjoy the added advantage of the increased liquidity that the stock will now enjoy.
On the overall stock market:Both these corporate actions would lead to a larger participation by all types of investor groups in the shares of the underlying company.
TAX IMPLICATIONS
Cost of shares: In the case of a bonus issue, the cost of the share is taken as nil. In the case of a stock split, the cost is proportionately divided between the original shares and the new shares in the ratio of the split. For instance, if the stock split is 1:1 and you have incurred a cost of Rs 100 per share (on the original share), the cost of the original share will now stand at Rs 50 and the cost of the new share you have received due to the split will be Rs 50.
Holding period of the shares: In case of equity, if you have held on to your shares for more than 12 months before selling, the profit is termed as long-term capital gain. If you have held on to your share for less than 12 months before sale, the profit earned is termed as shortterm capital gain. Presently, long-term capital gains on equity are tax exempt while short-term capital gains attract a flat tax rate of 10 per cent (+ education cess of 2 per cent + surcharge of 10 per cent, if applicable to you). In case of a bonus issue, the holding period of the bonus issue is taken from the date of allotment of bonus. In case of a stock split, the holding period is considered from the time of purchase of the original shares.
THE WAY FORWARD
Opt for a company which regularly announces bonus issues. However, it is imperative that the company should be financially sound, consistently record increasing profits, has a capable management and future potential. In the case of a stock split, do not be fooled into thinking that the stock is now available at a cheaper price. Remember that it is a psychological tool that the management uses to artificially reduce the stock price, and does not indicate the company’s profitability or future growth potential.
