On bonus issue.......Is it really a bonus?

I received announcement from one of my invested companies that it is issuing a bonus issue. There are always bound to be some interesting questions to an investor whenever a company raises any corporate announcements, in this case a change to it's capital share structure.

Is bonus issue a good thing or bad thing? I believe different people will have differing opinions on this. I am not trying to arrive at a definite answer because again different people will have their opinions on this, and neither one is correct nor wrong since it is just different perspectives to see the same issue (bonus issue).

A bonus issue is a method a company disburses it's dividends to shareholders in the form of shares instead of cash dividends. From my research, a company can choose to give out bonus issue instead of cash dividends to conserve cash. Does this means that a company must be cash tight in order to give out bonus issue? It is not always the case that a company must be cash tight to resort to bonus issue to reward it's shareholders. A company can give out bonus issue if it is trying to save cash for it's near future growth which may require large amounts of cash. So, giving out bonus issue does not necessarily mean a company is short of cash to resort to this measure to reward it's shareholders. A company may give out bonus issue to serve both functions of rewarding it's shareholders and conserving cash for deploying it in some targeted future growth opportunities.

As such, bonus issue is also considered as a scrip dividend whereby dividends is paid out in the form of shares instead of cash to it's shareholders.

Are there any other effects of bonus issue apart from shareholders expecting to receive dividends in the form of shares? Yes. Other effects include an increase in the number of shares since new shares are issued to shareholders in the form of bonus issue. To this, I believe there is no dilution of shareholder stake in the company since every shareholder is entitled to the same proportion of bonus issue with regards to their existing shareholding. However, another effect of bonus issue is the short term reduction in share price in proportion to the increase in number of shares through bonus issue.

Other effects include an increase in liquidity of the traded shares since more shares including the bonus issue will be now in the market. With the increase in the number of shares, investors should note that many financial ratios may be affected to a certain extent (especially if the increase in the number of shares through bonus issue is a large proportion to existing number of shares) such as a reduced earnings per share (EPS), reduced return on equity (ROE) and for value investors - a reduced estimated intrinsic value per share etc.

For me, the way I see bonus issue will depend on which company is issuing it. If a company with good growth and fundamentals is giving out bonus issue with the intention of rewarding it's shareholders, this is certainly welcomed. On one hand, there is no dilution of my shareholding and on the other hand, I get more "free shares" in the company. Some may have a counter arguement that what is the point of getting more "free shares" if the EPS and ROE will be reduced. This may be seen as just a short-term gimmick which does not have any practical profitability for the investor.

However, I already mentioned before that it all depends on which company is issuing the bonus issue. If a company is showing a good track record of consistent growth in it's EPS and also maintenance of strong ROE coupled with it's good business fundamentals and prospects over a good number of years (at least 10 years), there is a case for forecasting that the company can continue it's growth and profitability in years to come. In this case, "more of a good thing is a good thing". Owning more shares in the company can mean that the value of each share will increase in time to come. The short-term effects of reduction in EPS and ROE will be overcomed easily for a company that shows strong growth and profitability, especially when the proportion of bonus issue to the existing shares is not significant at all.

In conclusion, it all depends on who is issuing the bonus issue, a good company or a lousy one. Give me more of a thing that has good increase in future value and I will treasure it. Give me more of a thing that will in future depreciate in value, and I will be very sick to ask for more. An investor sees value when investing.......

Summary of effects of bonus issue:-
1. Increased number of shares in the company.
2. No change in stake of existing shareholders (though each shareholder now owns more shares "given free").
3. Reduction in various financial ratios such as EPS, ROE etc.
4. Reduction in estimated intrinsic value per share (applicable for value investors).
5. Reduction in share price after bonus issue (in proportion to the increase in number of shares).
6. Dividends paid out in the form of shares instead of cash (helps company to conserve cash).
7. Conserving of cash by company for future use (in growth opportunities??).