There are instances when a company is unable to pay dividends in the form of cash due to shortage of liquid funds. In such a scenario, it issues new shares to existing shareholders in the form of cash. These are known as bonus shares and offered in proportion to their dividends and shareholding rights. Read on to know more about the various aspects of such shares.

Events that lead to issuing of bonus shares

There could be a mix of circumstances that might warrant a company to issue bonus shares. These include:

  • In times of excess capital
  • Note that when a company is on a profit-making spree, the accumulated profits will keep on mounting. During such an event, the profit generated is much higher than the amount of share capital. In a bid to avoid abnormality in capital structure, the excess capital is distributed among existing shareholder through bonus share.

  • To enhance liquidity in the stock
  • One of the purposes of issuing bonus share is to increase liquidity of the stock and encourage retail participation. When a firm issues bonus shares, it sends a positive signal to the market that it’s in good financial health.

  • To satiate the shareholder’s need for a dividend
  • There are instances wherein an enterprise is not in a position to pay out dividends in the form of cash. In circumstances such as these, issuing bonus shares is the only viable alternative at the company’s disposal. Issuance of such shares is an indicator of the company being on solid financial footing.

Advantages of bonus shares to investors

As an investor, issuance of bonus shares holds several advantages for you. Some of them are:
  • You don’t need to pay anything extra to avail these shares. Hence, there’s a substantial increase in profits.

  • When you receive dividends, you need to pay tax on them. However, this is not the case with bonus shares. In other words, these shares are exempted from taxation.

  • If need be, you can convert these shares into cash by selling them at a higher price
Things to remember

  • It’s essential to note that you should not invest in shares of a company, purely with the intention of receiving bonus shares.

  • You must thoroughly research company fundamentals and proceed only should you feel that they are watertight.
Also, note that when you sell bonus shares, your stake in the company automatically reduces.

Financial prudence calls for using bonus share in a manner that can help you gain maximum mileage. Use them judiciously to enhance your profits.

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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.

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