Difference between Bonus and Stock Split
We must have heard that a company is giving bonus shares and a company is doing a stock split. Do you know the difference between the bonus and stock split? Let us try to understand the same:
Meaning of Bonus with example:
Bonus shares are fully paid additional shares given to already existing shareholders. For example, a company X announces that they will give a bonus share in the ratio of 2:1. First, let us try to understand the meaning of this. It means that if you have 1 share of company X then you will get additional 2 shares, so you will have a total of 3 shares. Does it mean that you will have 3 shares with a price of a share equal to the pre bonus level? No, it’s not like that. For example, company X has a share price of Rs. 3000 before the announcement of the bonus. After announcement and after the due date or record date or ex-date that is date when company price will be:
(Stock Price before ex-bonus)(Number of shares before ex-bonus)/(Number of shares before bonus)
(3000)(1)/3 = Rs. 1000
As you have 3 shares now so the total value is 3 multiplied by 1000 = Rs. 3000. That is the same value before bonus.
Similarly, if a company has a share value of Rs. 1000 announces that they will give a bonus share in the ratio of 1:1. If you have 1 share of the company then you will get an additional 1 share, so you will have total of 2 shares. So try to calculate the share value of total shares after bonus by the above calculation:
(1000)(1)/2 = Rs. 500
As you have 2 shares now so the total value is 2 multiplied by 500 = Rs. 1000. That is the same value before bonus.
One important point is there is no effect on the face value of a share due to the bonus. If company has face value 10 before bonus then will have a face value 10 after bonus.
Why company announces bonus?
One of the reasons may be to increase liquidity in market as number of shares increases and reward share holders as share price decreases and it becomes easier for retail investors to invest in a good company.
What is stock split?
As we have discussed about bonus, let us understand the meaning of stock split and so the difference between the bonus and stock split. You must have heard that a company decides that it will split the share in the ratio of 1: 2 or another company decided to split the share into ratio 1:5. First let us try to understand what stock split is.
For example, if the company A has face value of Rupees 10 and its share price is Rs 1000 and If the company decides that it will split the share in the ratio of 1: 2, it means that a split of 1 share at a face value of Rupees 10 each into 2 equity shares at a face value of Rupees 5 each. Then after stock split the share price will become 1000/2 that is Rs. 500. It means the share price of company reduces to half and the face value also. I hope you have understood the meaning of stock split.
Reasons to split the share:
The next question that might come in your mind is then why company do stock splits. There may be two major reasons, one is to increase the liquidity as stock split increase the number of shares so by increasing the number of shares it will not be easier to manipulate share price and second reason may be that more retail investors can buy the share at low price as stock split decreases the price value but there is no overall effect on valuation of share. According to me it is just psychological.
One important point is there is effect on the face value of share due to stock split as discussed above as face value reduces. There is no effect on PE ratio.
In nutshell, there is no effect on face value during bonus but face value reduces during the stock split. According to me the bonus is better than a stock split. What is your point of view? Please share in the comments section. Thanks.