Q&A: Bonus Shares, Investing in Companies making Cash Losses

Modified on July 23, 2018

The current article in this series provides responses related to:

  • Bonus shares
  • Investing in companies making cash losses

 

Query

Hello Sir,

A hypothetical situation. Suppose a company promoter pledged his 75% share & now that company is facing some management issue & lenders smell a rat here & sell all the pledged shares in the market due to which the share is continuously in lower circuit.

Now if the management decides to issue bonus share, then who will get the bonus share if the lender owning 75% share himself is in the queue for offloading it. For every seller there is a buyer but here there are no buyers.

What’s the point in issuing bonus share when the company is facing severe management & trust crisis?

The bonus issue is financed from the reserve & surplus so I want to know if the company has huge debt say ₹400 cr & R&S a/c have ₹600 cr, then why doesn’t the company pay the partial debt from the R&S a/c instead of giving bonus share.

If promoter & family don’t hold more than 51% of the shareholding than who will decide that who will run the company. All these things are they decided in AGM.

I myself tried finding all the answers but couldn’t get any so, at last, asking here.

After reading your articles on management I am very serious nowadays before investing in any company.

Happy Monsoon!

Author’s Response:

Hi

Thanks for writing to us!

1) A hypothetical situation. Suppose a company promoter pledged his 75% share & now that company is facing some management issue & lenders smell a rat here & sell all the pledged shares in the market due to which the share is continuously in lower circuit.

Now if the management decides to issue bonus share, then who will get the bonus share if the lender owning 75% share himself is in the queue for offloading it. For every seller there is a buyer but here there are no buyers.

When shares are pledged to the lenders, the shares are still in the name of the original owner. The lenders have the right to sell the shares whenever they need to recover the money. When lenders sell these shares, in the exchange records, it would look like the original owner/promoter has sold the shares.

Therefore, until the time the shares are pledged and are still in the name of the original owners/promoters, the original owner will get the shares and the lenders as a matter of prudence will pledge the newly received bonus shares as well.

However, once the lenders have sold the shares, then whoever is the new owner (buyer), he/she will get the bonus shares.

2) What’s the point in issuing bonus share when the company is facing severe management & trust crisis?

We believe that for all practical purposes of a retail investor, the bonus shares increase the number of shares available for trading and reduce the market price. They do not create any economic/business value on their own. However, many a times market take them positively. One of the reasons for it might be that after issuance the bonus shares, an equivalent amount is shifted from reserves and surplus to the share capital and it is very difficult to reduce the share capital without lengthy processes. So market might assume it a form of increased commitment by promoters to the company.

However, we believe that bonus shares do not do anything other than increasing the number of shares in the market and simultaneously reducing the share price of the stock to a lower level and thereby increasing the liquidity in the stock.

3) The bonus issue is financed from the reserve & surplus so I want to know if the company has huge debt say ₹400cr & R&S a/c have₹ 600cr, then why doesn’t the company pay the partial debt from the R&S a/c instead of giving bonus share.

Reserves and surplus is an accounting entry. It is different from the cash available with the company. Cash is shown under the current assets on the asset side of the balance sheet. To repay lenders, a company need to pay cash. To issue bonus shares, it is just an accounting adjustment where the figures in the reserves and surplus are now shifted/shown under share capital. There is no cash outflow in bonus shares.

4) If promoter & family don’t hold more than 51% of the shareholding than who will decide that who will run the company. All these things are they decided in AGM.

Many resolutions are passed based on the majority of the members present and voting. So non-voting members are not able to stop the resolutions from passing. Moreover, many times in the companies with less than 51% shareholding of promoters, most of the other shareholders are the ones who vote with the management. So the managements are able to get their way in the AGMs. Investor’s activism, which might stop promoters to take certain steps is still at very nascent stage in Indian markets.

Read: Why Management Assessment is the Most Critical Factor in Stock Investing?

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Query

I would like to know that if a company announces bonus issue or share split or increases its share capital than in such case what is the effect on earnings per share (EPS).

I understand that due to bonus issue or share split the number of outstanding shares will increase so the EPS will look small for the coming year. Then, in such cases how should I project the future EPS because, in comparison to the past, the expected EPS will look small.

I hope you understand my query.

Author’s Response:

Hi,

Thanks for writing to us!

In cases of bonus/split etc., while comparing the year on year performance, the past EPS should also be adjusted by the changing the requisite number of shares in the denominator. Only then the sequential year on year comparison will make sense.

In the case of the capital increase due to reasons of additional equity issuance/dilution, the fall in EPS is genuine and the resultant small EPS is the real fall in wealth of existing shareholders.

We do not do EPS projections. However, in case you are doing it, then using the latest number of shares to calculate future EPS seems the right method.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Query

Hi doc,

Today, I saw some scripts which are not good in their fundamentals like

Tata Metaliks Limited. The cash flow from operations (CFO) is negative in multiple years in the last ten year. Same is the case of Asian Granito Limited.

But these companies still manage to give multi-bagger results almost seven times within a year. So imaan dagmagane lagta hai.

Actually, CFO is the main factor to analysis as I have learned from you. So what should I do?

Should I invest in such type of companies, which produce almost nil or negative cash flow from operations (CFO) not only one but multiple in multiple years but still their share price increases multiple times within a year?

Please explain. Thanks

Author’s Response:

Hi,

Thanks for writing to us!

There are multiple approaches used by market participants to decide about the stocks which they would buy or sell. Our approach “Peaceful Investing” is one of such approaches.

If an investor believes that the stocks, which even though they do not have good fundamentals would give her good returns in future, then she can choose to follow her conviction.

However, stocks with weak fundamentals do not fit in our “Peaceful Investing” model and therefore, we tend to avoid them.

Read: Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Hope it answers your concerns.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Query

Sir

Greetings!

In a company, Eldeco Housing & Industries Limited, the standalone: “short-term loans and advances” of ₹53.82 cr. are greater than consolidated short-term loans and advances of ₹49.36 cr.

How consolidated loans and advances can be less than standalone numbers? Is it some subsidiary issue?

Author’s Response:

Hi,

Thanks for writing to us!

If a company has given loans and advances (L&A) to its subsidiaries, then these L&A would appear in the standalone financials. While preparing the consolidated financials, these L&A would be cancelled out as they are within the group (intragroup) transactions.

I believe that it might be the case in Eldeco Housing & Industries Limited as well.

For further clarity, you may read the annual report in details to know the parties to which L&A has been given.

Read: Understanding the Annual Report of a Company

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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