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Bonus Issue? What is it? Good or bad?

WHAT IS BONUS ISSUE?

Why after bonus issue I have more stock?


Bonus issue occurs when additional (free) shares are given to the existing shareholders, based on the number of shares they already have. For instance, if a company declares a 3:1 bonus, you will generally get 3 bonus share for each share you own. Hence, making you to have 4 shares on hand after the completion of bonus issue. Have a go at the quick test below to see if you understand the concept of bonus issue.

Bonus issue. Free stock? Price rise?
Sounds fantastic right? You just get some free shares! Hooray. But still, you need to know that there are several facts that you need to know about bonus issue.
  • Firstly, bonus shares are normally paid using the company’s retained earnings. This means that the available cash reserve for the company will reduce, which could possibly lead to lower dividend in future.
  • Secondly, bonus issue is sometimes considered as a substitution to dividend, in the form of non-cash repayment.
  • Thirdly, when the number of shares increases, the market normally balances the share price. It’s hard to explain this without a real scenario. Thus, let’s ignore this for a while and come back to this statement after going through the case study later. At this point of time, you just need to be aware that after bonus issue, the share price will normally decrease accordingly.
  • Fourth fact: Bonus issue is in fact a way to encourage retail investors’ participation in buying a stock. In the third point, we have discussed that the share price will drop. Now, when the share price is lower, more investors could afford to chip in.
  • Last but not least, issuing bonus shares increases the issued share capitals (outstanding shares to be specific). This could create a delusion that the company is larger than it really is.

 

 

CASE STUDY

After understanding the concept, let’s have a look at a real case study. The selected stock is Hua Yang, a property counter. Back in 2013, the company announced bonus issue on the basis of 1:3. So, for every 3 existing shares, the shareholder will get 1 bonus share. From the notice, we can see that the company issued 66,000,000 of new bonus share. At the par value of RM1, therefore, the total share capital is increased by RM66 million. At the same time, RM66 million was deducted from its 2013 retained earnings, as the bonus issue was funded by the company’s retained earnings.

Bonus Issue example, Huayang, KLSE, what is bonus issue

How much will the share price be adjusted after bonus issue?

Now, recall back what we have discussed in the third fact earlier, the market will readjust the share price after bonus issue. Looking at the historical price chart below, you will notice that HUAYANG share price dropped from RM3.07 to RM2.39 just in a day. See, this is how the market balances itself, which also reflects the perceived fair price by the market.

To predict how much will the share price change, it is not hard too. Using the basis of every 3 existing stock produces 1 bonus stock, RM3.07* (3 stock)/(3+1)stock=RM2.31.

How much will the share price be adjusted after bonus issue?

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