The Money Spinners: Bonus Shares, Dividend & Rights Issue

The Money Spinners: Bonus Shares, Dividend & Rights Issue

The Money Spinners Bonus Shares, Dividend & Rights Issue

The stock market investment is not just about buying and selling of the securities. There is a lot more to your stock investment which you learn as you gather experience. The investors who have a long-term view of the equity investment not only benefit from the returns of their stocks but also gain from other incentives like dividends, bonus shares, split shares and sometimes even rights issue. Every company, in order to do business, needs a capital infusion from time to time. The journey starts from IPO where it raises funds from the public but in future, they may need more funds to keep the operations on. In such situations, companies have to resort to solutions prescribed by SEBI.

Let's take a look at all important events that a corporation goes through and how an investor stands to gain or lose due to their occurrence. To understand all these better let's take a running example of Company X and try to understand how Company X deals with its operations in the thick and of its financial health.

Suppose, Company X is a private limited company in the textile business and wants to raise funds to expand its business. For the expansion purpose, the company needs to raise Rs.10 crore. The management of the company decides to go public.

Company X floats its IPO.

Once the company becomes a public ltd company, there are several obligations that are imposed on the company by SEBI. These obligations are in the interest of the investors. One of the obligations is that the company has to make all its financial records i.e. balance sheet, P&L statement, cash flow statement public. Also, a company has to announce its performance of every quarter. This data is important for the investors to see how the company they invested in is functioning. The annual and quarterly earnings reports also work as an indicator of the operational and management efficiency of the company. Based on the quarter on quarter and year on year growth of the company an investor can take a call whether he/she want to invest in the company.

Post listing, naturally, Company X will have to adhere to all the obligations directed by SEBI. Now they have to announce their quarterly results every quarter and have to call for an annual general meeting and announce annual returns at the end of every financial year.

In the subsequent years, after getting listed, the company delivered good returns thanks to the efficient management and robust financials and growing sales. As the company has reported profits, its management decided to give the dividend to its shareholders.

Company X Announces Dividend

After the quarterly meeting Company X announces the dividend payout of 50 paise for every fully paid up share. This means if you hold 100 shares of X Company you are entitled to get Rs.50 as a dividend.

What Is Dividend?

When a company reports profit and after paying all taxes and creditors has surplus cash on hand, it can opt to distribute a part of its earnings amongst its shareholders. This cash reward is called dividend. A company which pays regular dividends is considered to have a healthy cash flow which reflects company's fluency in managing debts and operating margins. The companies which have high dividend yield are considered good for investment with a long-term investment vision. However, there is no obligation on the company to pay the dividend to the shareholders and it's entirely company management's prerogative whether to give and how much dividend to give to the shareholders.

Company X Announces Bonus Share

3 years after getting listed, Company X's performance in the equity market has been terrific, to say the least. It has reported consistent growth with a healthy return on equity for the investors. In the current quarter, the company has announced that it will give bonus shares to its shareholders in the ratio of 1:1. It means if you have 100 shares you will get 100 additional shares.

What Is Bonus Share?

Bonus shares are the additional shares given to the existing shareholders. A ratio and record date is decided by the company and all the investors who hold the company shares on the record date are entitled to get the bonus shares. Bonus share is a reward for the investors. However, there is also an ulterior motive of the company behind it. By offering bonus shares the number of outstanding shares increases while the value of the share is adjusted (decreased) at the same time the company's stock, with the revised price, becomes attractive to new retail investors. Bonus share is a win-win situation for a company and for the investors. In the event of the bonus shares, the face value of the share doesn't change.

Company X Splits Shares

5 years after going public Company X has fared extremely well in the stock market. Its share value has grown exponentially from Rs.250 apiece to Rs.3,000. The company has outperformed its peer group and has left many of the companies behind by a handsome margin. However, as the stock price of the company has risen considerably the management fears the liquidity of the stock might suffer.

Taking into account the apprehensions regarding the liquidity, the management decides to split the share by the ratio 5:1. It simply means one share of Rs.3000 will be split into 5 shares of Rs.600.

What Is Split Share?

Splitting shares is an option a company can exercise when it feels the price of its stock has become too big to look attractive to retail investors. This is a safe way to adjust the price without hampering the market capitalisation and the interest of the existing shareholders. Almost all the big companies split their shares from time to time. The splitting is done with a certain ratio e.g. 2:1 or 5:1. In the event of the share splitting, the face value of the share changes.

Company X Offers Rights Issue

For last several years Company X has been doing great business. The company's stock has turned out to be a major wealth builder for the investors. The consistent year on year growth with high penetration in the rural and urban market has made the company highly profitable.

The good thing about the company is that it hasn't run its course yet. With the strategic expansion plans, the company has still a lot to offer. However, the company is facing some cash crunch. The debt repayment and operational cost have been on the higher side. Now the company has the expansion plan but is short of cash. Usually, in such situations, companies turn to banks to borrow money. But X Company doesn't want to add to the existing debt burden so in order to raise more funds, they decided to float a Rights Issue.

What Is Rights Issue?

The rights issue is the method through which a company raises additional capital. However, the rights issue is only available to the existing shareholders of the company. For instance, if A holds 200 shares of B company and the B company brings a rights issue with the ratio of 10:1 (For every 10 shares you can apply for 1 share). In this case, A has 200 shares so he/she can apply for 20 shares.

Now you would be wondering why A would apply for the shares through the rights issue when he can get it from the open market? Discount! Yes, in a rights issue the shares are offered at a discounted price.

To float a rights issue the company has to get an approval from SEBI and has to announce the record date and the share price well in advance.

Though rights issue is an opportunity for an investor to accumulate more shares at a lower price, it is also a matter of concern. The core reason for a company to bring rights issue is that the company is facing a severe cash crunch which only reflects its sloppy money management. The company which cannot manage its cash efficiently can never be a bright prospect for an investor. Therefore before applying for a rights issue, it's important you review the financial statements of the company and ensure that the company's financial standing is reliable.

Conclusion

In 10 years, Company X not just gave investors returns on their initial investment but generously shelled out dividends on the regular basis. Also, the company offered bonus shares and split its shares once which multiplied the stock holding of the investors. When the company was short of cash it again gave an opportunity to the existing investors to buy more shares at a lower price via a rights issue. Assuming the company has managed its cash diligently post rights issue it is very likely that its stock will again touch new highs in the future. As a result, the investor who had got the shares in the IPO and held it through all the ups and downs stands to gain an enormous fortune.

Company X is, of course, a fictitious company but there have been various companies in the Indian stock market who have given staggering returns over the years. The blue-chip giants like Reliance, Asian Paints, Infosys and many more such companies have given unimaginable returns to their long-term investors.

All an investor needs to do is find quality stocks, buy them when they are undervalued and then sit tight and watch the money grow. Long-term investment is the key to success. Let's take a look at one such company which, over the years, has brought enormous wealth to the investors.

Infosys - A Gigantic Success Story!

Infosys got listed on Bombay Stock Exchange (BSE) in June 1993. Would you believe me if I tell you that Infosys at the issue price of Rs.95 per share was actually undersubscribed? It's hard to believe but it's true. However, the stock got listed at Rs.145, giving 60% gains on listing day. But that was just a start, what Infosys went on to do, thanks to its industrious business operations, became the golden chapter of Indian equity investment. Today, 25 years after its listing and after numerous splits and bonus shares offerings, the stock price stands at Rs.1159. Remember, the company has been paying regular dividends, too.

To illustrate the gravity of this point let's take a hypothetical situation. Suppose you had bought 200 shares of Infosys on the day it got listed it would have cost you (145*200) Rs.29,000. If you would have just held the shares to date, let's see where it would stand.

 

Year Face Value Action Ratio Shares in hand
1993 10 Shares bought in open market NA 200
1994 10 Bonus 1 : 1 400
1997 10 Bonus 1 : 1 800
1999 10 Bonus 1 : 1 1,600
2000 5 Split 2 : 1 3,200
2004 5 Bonus 3 : 1 12,800
2006 5 Bonus 1 : 1 25,600
2014 5 Bonus 1 : 1 51,200

You would be sitting on the fortune worth Rs.5,93,40,800.

Let me state it again - This fortune was generated with the initial investment of Rs.29,000.

That's the power of equity. That's the power of long-term investment.

 

ABOUT AUTHOR

Niveza Editorial Desk : We are a team of stock market nerds trying to stay ahead of the herd. We spend our grey cells everyday to a pave a smooth road for our clients in the shaky world of stock market. While tracking the mood swings of the market we bring our clients the most rewarding deals.

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