Bonus Shares and Stock Splits, Explained Simply

In a bonus issue, a company gives existing shareholders additional shares for free, in a fixed ratio. For example, a "1:1 bonus" means one extra share for every share you own. The company converts part of its reserves into share capital to do this.

In a stock split, a company divides each share into several smaller shares. For example, in a two-for-one split, every share you held becomes two shares, and each new share has half the earlier face value.

The company value does not change because of a bonus or split. So if the number of shares doubles, the price per share roughly halves. If you had shares worth a certain amount before, you have about the same total value after, just spread across more shares.

• To make the share price more affordable for small investors.
• To increase trading activity in the share.
• To signal confidence in the future, in the case of bonus issues.
• To reward long-term shareholders symbolically.

As with dividends, you must hold the shares by a record date to get the bonus or split shares. On the ex-date, the price adjusts. The new shares are credited to your demat account some days later.

Our page on what a dividend is explains record dates.

The price per share is lower, but the company is not cheaper. Valuation depends on the total company value compared with its profits, not on the price of one share. A lower share price is not a reason to buy on its own.

Our page on market capitalisation explains how company value is measured.

Sometimes share prices rise after a bonus or split announcement because of excitement or improved liquidity. Such moves are often short-lived. Long-term value still depends on the company business.

The cost of acquisition and holding period for bonus and split shares follow specific rules, which matter when you later sell. We do not quote tax rules or rates. A tax adviser can help.

When a company held by your mutual fund issues bonus shares or splits, the fund simply holds more shares at a lower price. The fund value and your NAV are not affected by the event itself. You do not need to do anything.

Our page on what NAV is explains how fund values are calculated.

Mutual funds generally do not split their units or issue bonus units in the way companies do. A fund with a high NAV is not expensive, and a low NAV is not cheap. What matters is how the NAV grows.

Our pages on mutual fund units and mutual fund myths explain this.

Occasionally, companies do a reverse split, combining several shares into one. This raises the price per share without changing total value. It is less common and sometimes happens with struggling companies.

Some investors buy shares just before a bonus record date, expecting a gain. Because the price adjusts, there is no automatic profit. Buy shares, or funds, for the long-term business value, not for corporate actions.

Our page on how the stock market works explains what drives prices.

After the record date, the extra shares are credited to your demat account, usually within a couple of weeks. Your holding statement will show the higher number of shares at the new adjusted price. If the credit does not appear after a reasonable time, contact your broker or depository participant.

A rights issue is not free. In a rights issue, a company offers existing shareholders the chance to buy new shares, usually at a price below the market price. You have to pay to take them up. Unlike a bonus or split, money actually moves from shareholders to the company.

Companies usually issue bonus shares when they have built up large reserves, which can be a sign of past profits. But a bonus does not tell you how the business will do in future. Judge a company by its business, profits and debt, not by how often it issues bonus shares.

Our page on the Nifty PE ratio explains one way investors look at valuation.

Tracking bonuses, splits, record dates and credits across many shares takes effort. When you invest through a mutual fund, the fund manager handles all these corporate actions for you, and you simply see the NAV. For many families, that simplicity is a big reason to invest through funds rather than individual shares.

After a bonus or split, your average cost per share falls in the same proportion as the share count rises. Your total cost stays the same. Brokers usually update this automatically, but it is worth checking your holding statement so that your gain or loss is shown correctly when you later sell.

• Bonus: free extra shares from reserves.
• Split: each share divided into smaller ones.
• Total value stays about the same.
• Mutual fund investors need not act.

We are distributors rather than investment advisers and we recommend no schemes. If you want help understanding your investments, get in touch.