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Thread: Bonus issue and it's effect on stock prices

Bonus as the word suggest refers to something that is received without consideration or price. A company may reward it's shareholders in form of cash payouts (dividends) or stock payouts (bonus issue).
Bonus issue is carried out by company having huge amount of free reserves that can be capitalized. Eg: A company has been making profits and accumulated free reserves. These reserves can be used to issue bonus shares which converts them into share capital.
Let us say a company has Rs. 1,00,000 of share capital and Rs. 1,00,000 in reserves and surplus. Company has 10,000 shares outstanding of face value Rs. 10 each.
If the company decides to issue a bonus of 1:1 (1 share in bonus for 1 share held),
The company will need to move Rs. 1,00,000 (Rs. 10 x 10,000 shares) from reserves to share capital.
Now once the bonus issue is carried out, the stock price falls to the level where shareholders wealth remains unchanged.
Eg: Suppose a stock is worth Rs. 1,000 and company decides to issue a 1:1 bonus. So every shareholder will get 1 free share for every share held. This will reduce the price of stock to Rs. 500 thereby keeping the wealth unchanged.
TIP: Issuing bonus shares instead of dividend helps company preserve it's cash as bonus shares do not involve any cash outflow from the company.
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