Effect of Bonus Shares and Stock Split on Long Term Returns?

I’ve written an article on long term investment as a strategy. Experts also write on this topic. But even in their write-ups, you’ll not find an explanation about the effect of bonus shares and stock split on investor’s returns.

What is the effect? For some good stocks, which issue bonus shares and does stock splits, the effect is phenomenal. You can check this video to know how you can calculate its impact yourself.

But why not many people talk about it? Probably the reason is the duration of holding required to see the effect. People need to hold their shares for an insanely long period of time, like 15+ years, to notice the effect of bonus shares and stock split.

Bonus shares and stock splits are not a common phenomenon. I could get a feeling from my study that, in a period of 20 years, bonus shares or stock splits will happen twice or thrice. Hence investors who hold on to their stocks for 3 to 5 years, may not see a stock split or bonus issue even once.

Why I’m writing about it? Because it gave me a new realization and motivation to buy a good stock and hold on to it for very long time. Read: How to invest in the share market.

Before going into more details, let’s first know about bonus shares and stock split.

Video : Bonus shares and stock splits

About Bonus Shares

Bonus Shares - Authorised capital

Before you read about bonus shares, I’ll suggest you read this article on authorized capital and paid-up capital. It will help you understand the concept of the bonus shares issue better.

Bonus share is the issuance of additional shares to existing shareholders (paid-up shares) of the company. This is a simple understanding. But allow me to explain the accounting behind it.

Suppose there is a company that wants to issue bonus shares to its shareholders. Its shareholders falling under the category of paid-up shares is, say 2 crore numbers. Face value of shares is, say Rs.5 per share. Hence the total share capital of the company will be Rs.10 crore (=2 crore x Rs.5).

Accounting - bonus shares
Now, the company wants to issue bonus shares in a 1:1 ratio.

From the shareholder’s perspective it means, for every one share held by the shareholder, they will get one additional share.

Bonus Shares - how to read the ratio

From the company’s perspective it means, it will have to issue 10 crore more shares having a face value of Rs.5. It means, the company will have to self-finance Rs.50 crore and issue the bonus shares for free to the shareholders. From where the financing will be done? As per rules, it can be done out of the company’s reserves. Read about retained earnings.

Upon the issue of bonus shares, the company’s share capital will increase by Rs.50 crore and its reserves will reduce by the same amount. Hence, after the bonus issue, the share capital will increase from Rs.10 cr to Rs.60 Cr, and Reserves will reduce from Rs.100 cr to Rs.50 cr. Check the above table:

In short, we can say, after the bonus shares issue, Share Capital increases and reserves decrease. The next effect is that the overall net worth of the company remains unchanged.

It must also be noted that, upon bonus issue, if the paid-up capital increases and becomes more than the authorized capital, then the Memorandum of understanding (MOU) document must be amended to accordingly increase the authorized capital with the registrar of companies.

Example of Bonus Issue:

If bonus shares are issued in the proportion of 1:3, it means that for every 3 shares held by a shareholder, they will get 1 additional share. Suppose there is a shareholder who has 30 numbers shares of a company. Under the bonus shares issue of 1:3, the shareholder will get 10 new shares. After the bonus issue, the total number of shares held by the person will increase from 30 nos to 40 nos.

About Stock Split

A stock split is basically an action taken by the company to reduce the face value of its stock, by splitting it into more number of shares.

Suppose there is a company whose number of shares outstanding in the market is 1 crore. The face value of each share is Rs.10. The total share capital of this company, as visible in its balance sheet will be Rs.10 crore (=1 crore x Rs.10). Suggested Reading: Difference between face value, book value, market value, and intrinsic value.

Please note this rule – the share capital of the company shall remain unchanged after the stock split.

Now, suppose the company decided to do a stock split. They wanted the face value of each share to be lowered from Rs.10 to Rs.2. Here the face value is getting lowered by 5 times. Now, in order to keep the share capital unchanged, they must split each share into 5 more shares.

Stock Split - FV, share capital, no of shares

This is an example of a stock split in a 4:1 ratio. It means, for every stock held by a person, after the stock split he will get 4 number more shares. If a person owns 10 nos stocks before the stock split, after the split he will own 50 nos (=10+40 nos) stocks.

Why Company’s Split Their Stock?

We have already seen that the stock split does not change the company’s share capital. Hence we can say that, in terms of balance sheet numbers, companies gain nothing from stock splits. So why they go for the stock split?

There can be several reasons why a company may opt for the stock split. The first and foremost reason is that it allows companies to keep it’s stock prices low. What is the logic behind keeping the stock prices low?

It is investors’ psychology that makes them hesitant in selecting a stock whose market price is too high. Hence, good stocks trading at low price levels often have high trading volumes.

Suppose a blue-chip stock is trading at Rs.10,000 per share. Another blue-chip stock trades at Rs.100 per share. What do you think, which stock you are more likely to trade? I’m sure it will be Rs.100 per share one, right?

Low price stocks are often retail investor-friendly. They often exchange hands more frequently than high price stocks. This is the reason why the company split its stocks to keep its market price low. This eventually increases its trading volume.

Effect of Bonus Shares and Stock Split on Long Term Returns?

Recently I was calculating past returns generated by shares of few companies. I was trying to calculate the returns generated by them since the day they started trading in the stock market.

Initially, I thought it would be quick work. I’ll pick the end to end price and calculate the CAGR (return). If a company got listed in the Yr-2000, in BSE, then I will note that price. I’ll also record it’s today’s price. The period between these two dates will be 20 years. 

With these numbers in hand, I’ll easily calculate the CAGR using this formula (check this video).

But I soon realized that I’ve missed considering the factor of stock splits and bonus shares issued by the company in the last 20 years. When I factored in the effect of stock split and bonus shares, the result was very different.

I’ll request you to check this video to see yourself the impact of stock splits, and bonus shares on the long term return generated by the company.

Conclusion

Buying stocks of good companies and holding on to their shares for the long term has its own benefits. But this benefit may get compounded when the company issues bonus shares and do stock splits.

It is true that not all companies can benefit their shareholders by means of bonus issue and stock splits. But shareholders of fundamentally strong companies will surely benefit from it.

Check this video to see how to calculate the return generated by a stock after considering bonus issue and stock splits. Apply the same calculation for companies like RIL, Wipro, etc. I’m sure you will be surprised to see the end result.

To experience the real benefit of bonus shares and stock split, the shareholder must hold on to their shares for a very long time. Here the length of time may be in tune of 15 to 20 years.

To get a ready list of companies that issued bonus shares and did stock splits in recent days, check the two links.

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Hi. I’m Mani, I’m an Engineering graduate who in pursuit of financial independence, has converted into a full time blogger. After working in the corporate world for almost 16+ years, I bid it adieu....read more

14 thoughts on “Effect of Bonus Shares and Stock Split on Long Term Returns?”

  1. I think Mr.Mani is correct.
    As an investor, I spent only Rs 15.14 .After 20 years ,what I got is the final amount after redemption.So the return is based on final realized amount and initial cost of purchase.

  2. LETS SUPPOSE PERSON BOUGHT ONE SHARE IN 2000.

    POINT NO 1: ONE STOCK PURCHASED IN YEAR 2000 HAS BECOME 120 AT PRESENT( AFTER SPPLIT AND BONUS).

    POINT NO 2: SINCE THE PROPORTION IN WHICH STOCK IS SPLIT OR GIVEN BONUS ALSO RESULT IN DECREASE IN PRICE OF SHARE BY SAME PROPORTION, CALLED EFFECTIVE ADJUSTED STOCK PRICE.

    SO , SINCE 1 STOCK HAS BEEN DIVIDED IN 120 STOCK SO INITIAL TRUE VLAUE OF 1 SHARE SHOULD BE 15.4X120 NOT 15.4 ( ACCORDING TO POINT NO. 2)

    SO BASCICALLY YOU CAN SEE WHOLE THING AS PERSON BOUGHT 1 SHARE IN 2000 AT COST OF 15.4X120=1816.8
    AND AT PRESENT HE HAS 120 SHARE WITH EFFECTIVE ADJUSTED STOCK PRICE AS 15.4 IN 2000 .

    STOCK SPLIT AND BONUS DOES NOT CHANGE TOTAL VALUE OF INVESTMENT . SO TOTAL INVESTMENT IN 2000 IS 1816.8 NOT 15.4.

    IF YOU TAKE 15.4 AS INITIAL INVESTMENT THEN DON’T CONSIDER STOCK SPLIT AND BONUS AGAIN IN CALCULATION. THAT IS RESULTING IN COUNTING SAME THING TWICE AND RESULTING IN VERY HIGH CALCULATED CAGR.

    1. IF YOU…DON’T CONSIDER STOCK SPLIT AND BONUS AGAIN IN CALCULATION” – Incorrect argument

      Moreover, the price at which the shares are sold will be the current price at which the stock is trading in the market.

  3. Well written article.
    Two mistakes. However, they do not lower the quality of context, though may have confused some of the avid readers, but only to ignore these at last. I shall be glad to point them out in private.
    This is my second visit to Manish’s page, and that too after a gap of a few covid laden months. But I am happy to state, I sure was impressed about the illustrations and diagrams, which are unique, and characteristic of a clear mind of this techno-finance wizard.

  4. Excellent Video shared on sun Pharma, It is very inspiring to draw a investor to invest in equities, Your narration has been again out standing and gives a great confidence to be in stock market.

      1. HELLO MANI!

        I AM POSTING MY COMMENT IN HOPE THAT YOU WILL REPLY. SO PLEASE REPLY TO THIS.

        I SAW YOUR VIDEO OF SUN PHARMA CAGR CALCULATION.

        I THINK THERE IS SOMETHING WRONG IN YOUR CALCULATION. OR I AM WRONG ? LET ME KNOW.

        SO I THINK YOU ARE TAKING ONE THING IN ACCOUNT TWICE THAT’S WHY CAGR RETURN IS SO HIGH.
        SINCE, PRICE SHOWN IN CHART IS ALL READY ADJUSTED PRICE AFTER STOCK SPLIT AND BONUS.
        SO IF YOU ARE TAKING INITIAL VALUE AS 15.14 INR THEN YOU SHOULD NOT TAKE STOCK SPLIT AND BONUS IN ACCOUNT . BECAUSE, THOUGH STOCK SPLIT AND BONUS INCREASES NUMBER OF SHARE BUT AT SAME TIME IT ALSO DECREASES THE SHARE VALUE BY SAME PROPORTION. SO IF WE HAVE TO TAKE SHARE SPLIT AND BONUS INTO ACCOUNT THEN WE HAVE TO TAKE INITIAL VALUE OF SAHRE AS 15.14X120=1816.8 ( 120 = 120 IS WHAT 1 SHARE HAS BECOME AFTER SPLIT AND BONUS.).

        WE CAN’T TAKE INITIAL VALUE AS 15.4 AND THEN ALSO TAKE SPLIT AND BONUS INTO ACCOUNT BECAUSE IT MEANS THAT EVEN AFTER STOCK SPLIT AND BONUS VALUE OF SHARE REMAINS SAME WHICH IS NOT TRUE STOCK SPLIT AND BONUS DECREASES THE VALUE OF SHARE BY SAME PROPORTION BY WHICH IT INCREASES THE NUMBER OF SHARES.

        IN THE CALCULATION IN VIDEO WE ARE TAKING SHARE SPLIT AND BONUS INTO ACCOUNT BUT NOT CONSIDERING THE DECREASES IN VALUE OF SHARE DUE TO STOCK SPLIT AND BONUS. WE ARE TAKING SHARE PRICE AS ALWAYS SAME AND AT SAME TIME WE ARE ALSO INCREASING TOTAL NUMBER OF SHARE .

        WE HAVE TO TAKE INITIAL VALUE AS 15.14X120=1816.8 IF WE WANT TO TAKE STOCK SPLIT AND BONUS INTO ACCOUNT .

        SO MANI IF I AM WRONG . PLEASE REPLY. I WROTE ALL THIS BECAUSE I THINK YOU WILL REPLY.
        THANKS.

        1. I think there is no mistake in the calculation. Try yourself the following calculations:
          1) How much money was invested?
          2) How much money was received on redemption?
          3) Calculate the CAGR growth rate.

        2. MANI,
          MONEY INVESTED WAS 15.14X120= 1816.8 BUT YOU ARE TAKING IT AS 15.4

          `15.4 IS ADJUSTED STOCK PRICE AFTER SPLIT AND BONUS .
          SO IF ONE HAS TO CONSIDER STOCK SPLIT AND BONUS INTO ACCOUNT THEN WE HAVE TO TAKE INITIAL VALUE AS 15.4X120 WHICH IS 1816.8

          AND IF WE WANT TO TAKE INITIAL VALUE AS 15.4 THEN WE SHOULD NOT TAKE STOCK SPLIT AND BONUS INTO ACCOUNT. BECAUSE 15.4 IS ADJUSTED STOCK PRICE .

          THESE ARE TWO WAYS IN WHICH WE CAN CALCULATE CAGR.
          BUT IN YOUR CALCULATION YOU ARE MIXING BOTH YOU ARE TAKING ADJUSTED STOCK PRICE AS INITIAL VALUE AND ON TOP OF THAT YOU ARE CONSIDERING STOCK SPLIT AND BONUS.

          1. If a person has purchased ONE stock in Year-2000 @Rs.15.4/share then the money spent to buy the share (invested) will be Rs.15.4 only (not Rs.15.4 x 120). It is impossible. Just because there will be ‘stock splits’ and ‘bonus issues’ in the future, it will not change his cost of purchase.

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