Bonus Vs Stock Split – The Difference

Is there any difference between Bonus and Stock Split? The answer is Yes. As retail investors, we should know the key difference and how they can impact our investment.

So today, I will share the three key differences between bonus and stock split. Further, I will explain the same with an example. Then, I will share why the stock price skyrockets when a company issues a bonus.

So without much ado, let’s begin.

What is Bonus and Stock Split?

When a company announces a 1:1 bonus or 1:1 stock split, the share price halves, and you get twice the number of shares.

So per se, there seems no difference, but there is a huge difference. First, let us understand what is Bonus Shares and Stock Split.

Bonus

Bonus shares means the company is issueing new shares to its existing shareholders using the companies reserves or cash in the books. The increase in stock quantity is arithmetically neutralized by the proportionate fall in stock price on the day when the company goes ex-bonus.

Stock Split

Stock split is reduction in face value of each share. Shares at the time of formation of a company are issued in standard denominations of Rs. 10. However, prices of such shares go up and company may decide to reduce the price by making the face value of each share lower. In the market companies split if the share price becomes too high for retail investors. So companies split the shares by decreasing the face value of each share with a split. The face value of each share of Rs. 10 when split for 1:1 will become a face value of Rs. 5 each.

In India, we have a face value of Rs. 10 and then as the stock splits. However, in many developed markets, all shares have a face value of unity (Re. 1). As everything has the same face value of 1, there is no concept of split. So everything is a bonus which is termed as split there. What we term as a 1:1 bonus in India is a 2-for-1 split in the US.

Difference between Bonus and Stock Split for Retail investors?

When a company announces a 1:1 bonus or 1:1 stock split, the share price halves, and you get twice the number of shares.

As an investor, we think both are the same. However, three main differences can impact a retail investor. So let’s understand them.

The Purchase Date

In case of a split, the company is changing the face value of a share. The share face value change has impacted the price and the number of shares outstanding.

So for an investor, there is no change in the purchase date.

However, bonuses are new shares issued to existing shareholders.

So it is treated as if you purchased new shares on the ex-bonus day for free.

So old shares’ purchase date remains the same, and the new shares’ purchase date differs.

The Purchase Price

In case of a split, the company is changing the face value of a share.

So for an investor, there is a change in the original purchase price.

So for a 1:1 stock split, the purchase price for the share reduces to half.

However, bonuses are new shares issued to existing shareholders. It is to be treated as if you purchased new shares on the ex-bonus day for free.

So for bonus shares, the purchase price of old shares remains the same, and the newly issued bonus share is to be treated as purchased at ₹0.

Share Capital and Face Value

In a stock split, the face value changes, and there is no change in share capital.

However, in the case of a bonus, the face value remains the same, and there is an increase in the share capital.

Why Stock Price Rockets After Declaring Bonus?

When a company announces a 1:1 bonus or 1:1 stock split, the share price halves, and you get twice the number of shares.

So perse, there seems no difference for traders and investors. However, there is one reason why the stock price increases considerably when a company declares a bonus.

Now we know that in the case of a bonus, the cost price and the purchase date of the original share remain the same.

So if an investor receives new shares and the currently traded price of the old share reduces, and if he uses the FIFO method of accounting, he can sell the previously purchased shares and incur nominal tax.

Now investors can free up the invested capital, which is one of the main reasons many new investors want to be part of the company that declares a bonus.

So the stock price increases considerably.

Final Thoughts

I don’t think one should buy into a company only because it is issuing bonus shares.

The FSN E-Commerce Ventures, known as Nykaa, had announced a bonus ratio of 5:1. It was done just before the IPO lock-in ended for large investors.

It was primarily done so that investors will receive the ex-bonus shares late and so they cannot sell them on the day lock-in opens.

Moreover, newly issued shares will have higher tax as STCG is 15% and LTCG is 10%, so investors will want to hold the newly issued shares.

However, it wasn’t taken very positively. The ex-bonus date was on November 10, 2022.

Everything in the market has to be taken with a pinch of salt.