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Why Are Bonus Shares Issued?
  – By Prof. Simply Simple    TM




           We all know that bonus shares
           exist. But why are they issued in
                    the first place?


            Let me try & simplify this for
                        you…
• Let’s say a company makes Rs 1000 as profit

•Now suppose the company has 100 shares

•Then earning per share is profit/no. of shares = Rs. 1000/100 = Rs. 10
Suppose there is a surge in the
demand for company’s product
causing its profits to go up from
     Rs 1,000 to Rs 10,000!
One should observe is that
while the profit went up from
  Rs 1000 to Rs 10,000 the
number of shares remains the
         same at 100.
Hence, by definition, earnings
  per share would be 100.
Now, as we know that
   Market Price = EPS x P/E


If we were to assume a P/E of 10,
   the price per share would
       become Rs 1000…
At a price of Rs 1000, it would
  be very difficult to expect
 retail participation because
 any investor would need a
   minimum of Rs 1000 to
   purchase a single stock!
But that’s quite a large amount.
Say, an investor has only Rs 500 but
 wants to invest in this company.
          What does he do??
Despite having the desire to buy the
    stock, he will not be able to
  participate for want of money.
It, therefore, becomes essential for
   the company to increase the
  number of shares, so that the
price per share is within the reach
       of retail participants.
Let’s say the company declares
 a 1:4 bonus which essentially
 means that for every 1 share
you get an additional 4 shares.

So, in effect, you get a total of 5
             shares…
This would
increase the total
number of shares
from 100 to 500!
The earnings per
 share would now
     become
   EPS = Total
 Earnings/No. of
      Shares
       (or)
Rs (10,000/500 = Rs
        20)
And that would bring down the
   price per share from an
unaffordable Rs 1000 to a more
      amenable Rs 200
    (EPS x P/E = 20 x 10)
So in other words 100 shares x 1000 =
    Rs 10,000 is reconfigured as
    500 shares x 200 = Rs 10,000.
This division of shares thus
increases retail participation and
   hence liquidity to the stock,
making it easily tradable as more
  buyers and sellers are able to
  participate because of a lower
       unit value per share.

And our friend is also in a better
 position & can buy at least two
shares with his Rs 500 (2 x 200 =
  400) & he will be left with Rs
              100.
Thus we have seen how and why
 ‘Bonus Shares’ are issued in the
   stock market. Also we have
understood that the overall capital
 remains the same even if bonus
       shares are declared.
The only reason if at all for the
    stock price to go up would be
   because sentiments might turn
 positive by the news of bonus as it
   indicates that the company has
earned good profit and hence could
    continue to do so and thereby
attracting new investors and taking
           the price higher!
I will be glad to receive your feedback
  on this lesson to understand if there
                any gaps.

Your feedback will help me improve
    my lessons going forward.

 Also if you wish to demystify any
other concepts, do write to me about
                them.

    Please send your feedback to
       professor@tataamc.com
Disclaimer
The views expressed in these lessons are for information purposes only
      and do not construe to be of any investment, legal or taxation
   advice. The contents are topical in nature & held true at the time of
      creation of the lesson. They are not indicative of future market
  trends, nor is Tata Asset Management Ltd. attempting to predict the
    same. Reprinting any part of this presentation will be at your own
      risk and Tata Asset Management Ltd. will not be liable for the
                      consequences of any such action.




Mutual Fund investments are subject to market risks, read all scheme
related documents carefully.

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Bonus Shares

  • 1. Why Are Bonus Shares Issued? – By Prof. Simply Simple TM We all know that bonus shares exist. But why are they issued in the first place? Let me try & simplify this for you…
  • 2. • Let’s say a company makes Rs 1000 as profit •Now suppose the company has 100 shares •Then earning per share is profit/no. of shares = Rs. 1000/100 = Rs. 10
  • 3. Suppose there is a surge in the demand for company’s product causing its profits to go up from Rs 1,000 to Rs 10,000!
  • 4. One should observe is that while the profit went up from Rs 1000 to Rs 10,000 the number of shares remains the same at 100. Hence, by definition, earnings per share would be 100.
  • 5. Now, as we know that Market Price = EPS x P/E If we were to assume a P/E of 10, the price per share would become Rs 1000…
  • 6. At a price of Rs 1000, it would be very difficult to expect retail participation because any investor would need a minimum of Rs 1000 to purchase a single stock!
  • 7. But that’s quite a large amount. Say, an investor has only Rs 500 but wants to invest in this company. What does he do?? Despite having the desire to buy the stock, he will not be able to participate for want of money.
  • 8. It, therefore, becomes essential for the company to increase the number of shares, so that the price per share is within the reach of retail participants.
  • 9. Let’s say the company declares a 1:4 bonus which essentially means that for every 1 share you get an additional 4 shares. So, in effect, you get a total of 5 shares…
  • 10. This would increase the total number of shares from 100 to 500!
  • 11. The earnings per share would now become EPS = Total Earnings/No. of Shares (or) Rs (10,000/500 = Rs 20)
  • 12. And that would bring down the price per share from an unaffordable Rs 1000 to a more amenable Rs 200 (EPS x P/E = 20 x 10)
  • 13. So in other words 100 shares x 1000 = Rs 10,000 is reconfigured as 500 shares x 200 = Rs 10,000.
  • 14. This division of shares thus increases retail participation and hence liquidity to the stock, making it easily tradable as more buyers and sellers are able to participate because of a lower unit value per share. And our friend is also in a better position & can buy at least two shares with his Rs 500 (2 x 200 = 400) & he will be left with Rs 100.
  • 15. Thus we have seen how and why ‘Bonus Shares’ are issued in the stock market. Also we have understood that the overall capital remains the same even if bonus shares are declared.
  • 16. The only reason if at all for the stock price to go up would be because sentiments might turn positive by the news of bonus as it indicates that the company has earned good profit and hence could continue to do so and thereby attracting new investors and taking the price higher!
  • 17. I will be glad to receive your feedback on this lesson to understand if there any gaps. Your feedback will help me improve my lessons going forward. Also if you wish to demystify any other concepts, do write to me about them. Please send your feedback to professor@tataamc.com
  • 18. Disclaimer The views expressed in these lessons are for information purposes only and do not construe to be of any investment, legal or taxation advice. The contents are topical in nature & held true at the time of creation of the lesson. They are not indicative of future market trends, nor is Tata Asset Management Ltd. attempting to predict the same. Reprinting any part of this presentation will be at your own risk and Tata Asset Management Ltd. will not be liable for the consequences of any such action. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.