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This blog aims to clarify the confusion In Stock Split and Bonus Issue. Whenever a company announces Bonus Issue, don’t we get something extra that is absolutely free? And in case of Stock Split, doesn’t our share price fall drastically? Does it actually happen like this or what is its impact? So, in this blog, we will understand what is Stock Split and Bonus Issue. And how does it impact? First, let us talk about Stock Split.
The name speaks for itself. Stock Split is to split a share into small pieces. But the market cap remains exactly the same. Let’s understand it with an example. Let’s say we have an orange. Whenever we peel that orange slices come out of it, let us assume that 10 slices come out. Now we will not say that there are 10 oranges. Orange is one, but it has 10 parts. The same happens with a share as well. Share is one but gets divided into many parts.
In this case, if there are 10 parts of an orange, can we write it like this: 1:10, which means 10 parts of an orange. In this way even companies announce their Stock Split. You may have heard 1:2 or 2:3. In which our former figure is our original share. Such as 1. 1:2 means one share is divided into two parts. Now let’s simplify this more with numbers.
Let us assume that the price of this one orange is ₹1,000, so when we divide it into 10 parts each orange will have its own price. We divide the price of oranges by the number of parts to get the new share price. When we divide 1,000 by 10, the new price of each part of orange will be ₹100. That’s why whenever the company announces a Stock Split, the share price decreases, but the number of shares increases, whereas the market cap remains exactly the same. Let’s explain this with a better example.
When IRCTC announced its Stock Split, it announced in 1:5, means there will be 5 parts of one share. So where before the split the face value of the share was ₹10, whereas after the split its face value became ₹2. So before the split where the number of shares was 25 crores and their face value was 10, the share capital was 250 crores. Whereas, after split the number of shares became 125 crores, but the face value was reduced to 2. But share capital remained exactly same to 250 crores.
Why Companies Opt for Stock Split?
Now let’s talk about why a company announces Stock Split as we saw in example the share price falls.
If a company feels that its share price is too high people are not able to afford it that is why the company announces Stock Split so that the share becomes affordable. Liquidity also increases with this and the demand for the stock also increases.
Now let’s talk about our second corporate action, Bonus Share. Bonus Share is that whenever the company gives additional shares to you, but for those additional shares you do not have to give any amount to the company. Now you are thinking, where does the money come from? The answer is – Companies withdraw amount from their reserves, by doing this the number of shares of the company increases and like Stock Split market cap also remains exactly the same.
Like Stock Split, Bonus shares is also announced like 1:2 or 1:3. But there is a small difference here when we write 1:2 in stock split, then 1 is our original share and 2 means it will be divided into two parts.
But whenever the company announces bonus share of 1:2, in this case 2 is our original share and in exchange of 2 shares the company will give us 1 additional share. So if the company announces its bonus issue of 4:1 what does it mean? Means In exchange for 1 share, we will get 4 additional shares, so now our total number of shares is 1 plus 4 equals 5.
If the number of shares increases how does the share price adjust because the market cap remains exactly the same?
Suppose Bonus share price is ₹2,000 and we have 100 shares. So what will be market cap? Number of shares that is 100 multiplied by share price that is 2,000 is equal to ₹2 lakh. Now because the company had announced Bonus Share of 4:1 that means for 1 original share 4 additional bonus shares, our total comes to 5.
So even in this case to determine the new number of shares we will multiply 100 by 5, so 100 into 5 equals 500. And to determine the new share price of 2,000, we will divide it by 5, so it will become ₹400. So before the bonus number of shares was 100, the price was ₹2,000, and the market capital was ₹2 lakhs. After the bonus new number of shares became 500, the share price became ₹400 market capital remained exactly same as ₹2 lakh. Now it comes to why the company issues bonus shares?
Why Companies Opt for Bonus Issues?
Bonus shares come from the reserves, so when the company cannot give dividends it thinks about issuing bonus shares. Another reason is company wants to make its stock price even more affordable and increase its liquidity and demand. Now a question must be coming in your mind what is the difference between Stock Split and Bonus Share?
Because in both cases the number of shares increases the share price decreases and the market capital remains the same both are done to make the share price affordable and due to both of these liquidity and demand for that stock increase, then ultimately what is the difference?
In split face value changes to 5 and number of shares also increases to 4 crores hence new share capital value remains exactly the same ₹20 crores, reserves also remain same at 60 crores and total equity will be 80 Cr.
In a bonus issue the number of shares increases but the face value remains the same. if there’s a 1:2 bonus, for every 1 share, you get 2 bonus shares. If the company initially had 2 crores shares after the bonus it becomes 6 crores shares. The increase in value is adjusted from the company’s reserves.
And reserves will reduce from 60 to 20 crores, but our total equity remains exactly same, 80 crores similarly, in Stock Split, share capital gets adjusted and in bonus issue reserves get adjust. But our total equity, i.e., our market cap remains exactly the same.
So this was the difference between Stock Split and Bonus Issue. If you have any doubt in both these concepts, then you can ask us in the comment section below.
