Bonus Shares: Answers to Common Queries

Modified on July 3, 2020

The current article in this series provides responses related to:

  • Bonus shares and
  • Impact of bonus shares on earnings per share (EPS)

 

Bonus Shares

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

 

Impact of Bonus Shares on PE and PEG Ratio

Sir could you please give me some idea on adjusted eps and peg ratio (mainly when new shares are issued either bonus shares or right shares).

Do I need to adjust P/E ratio when new bonus or right shares are issued? If so, then historical eps will always be low since when new shares are issued, past earnings are to be divided by new increase number of shares and this gives the impression that eps is always growing.

And how to calculate peg ratio when new bonus or right shares are issued. G in peg is growth in eps. If there were no new shares, then eps and peg ratio will be easy to get and compare but with new shares, everything is diluted and I am confused what right method for getting correct calculations is.

Thank you very much.

Answer:

Hi Ramesh,

Thanks for writing to me!

There is no change in either P/E ratio or PEG ratio on the issuance of new shares under bonus shares. Both the share price as well as the EPS changes in the same proportion. For example, if one additional share for one existing share is issued, then both the share price, as well as EPS, will become half. The growth rate of EPS in percentage will remain the same. Therefore, there will be no change in P/E or PEG.

Read: How to do Valuation Analysis of Stocks

In the case of the rights issue, the issuance of new shares will bring in additional cash, which would lead to an increase in book value and reduction in debt to equity ratio, improved liquidity. Therefore, the equation will not be as simple as it was in the case of bonus shares. The market may increase or decrease the P/E ratio of the stock after the rights issue depending upon the market response.

In order to avoid the confusion related to change in EPS and price per share etc., which results in issuance of new shares, it is advised that investors calculate P/E ratio by the formula (Market Capitalization / Net profit after tax). This formula will simplify the understanding for the investor as the net profit figure does not change upon issuance of new shares.

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Impact of Bonus Shares on EPS

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

 

 

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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