How does a company spend its money to buy bonus shares?
How does it work?
Are you referring to how company uses its funds to buy back its own shares or are you asking how a bonus shares is issued by a company and its impact on its financials?
Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends, but are converted into free shares.
The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding. For instance, if Investor A holds 200 shares of a company and a company declares 4:1 bonus, that is for every one share, he gets 4 shares for free. That is total 800 shares for free and his total holding will increase to 1000 shares. However please note that just because you got more shares in number terms the market value will remain the same.
In the above example earlier you had 200 shares and the market value was say 100. Now after the bonus shares issue, you have 1,000 (200 + 800) shares and after the bonus issue, the market price will be 20.
Earlier 200 x 100 = 20000
Now 1000 x 20 = 20,000
Companies issue bonus shares to encourage retail participation as well and increase their equity base. When price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. Increase in the number of shares reduces the price per share. But the overall capital remains the same even if bonus shares are declared.
ADVANTAGES OF BONUS SHARES (copied from Kotak Securities)
- There is no need for investors to pay any tax on receiving bonus shares.
- It is beneficial for the long-term shareholders of the company who want to increase their investment.
- Bonus shares enhance the faith of the investors in the operations of the company because the cash is used by the company for business growth.
- When the company declares a dividend in the future, the investor will receive higher dividend because now he holds larger number of shares in the company due to bonus shares.
- Bonus shares give positive sign to the market that the company is committed towards long term growth story.
- Bonus shares increase the outstanding shares which in turn enhances the liquidity of the stock.
- The perception of the company’s size increases with the increase in the issued share capital.