Understanding on Bonus Issue Vs Right Issue

By investing in the stock market, the investors are becoming a shareholder of a particular company through buying the specific stock. As a shareholder, investors will be updated from time to time about the company’s new direction including announcements of “Bonus Issue” and “Right shares Issue”. Both seem alike, but there are a different so all shareholders should understand what differentiates between Bonus Issue and Right Issue and react accordingly.

Bonus Issue

Bonus Issue defined as free new shares issued to the existing shareholders based on the specified proportion of shares they are holdings which will be at free of cost. Bonus Shares is a conversion of the company’s accumulated earnings which are not given out in the form of dividends but converted into free shares.

When the bonus share distribution happens, it will increase the total number of shares owned by the firm. The Bonus shares do not inject fresh working capital into the company, as there are to distribute among the shareholders without any conditions. The net worth of the company will remain the same. Usually, bonus shares will pay up in full, and the shareholders are also allowed to sell those bonus shares to make a quick profit or save it for future gain.

Let us look at the example of bonus issue. If the company declares 3:2 of bonus issues, it means that every 2 shares held by shareholders, 3 Bonus share will be allotted to them. A shareholder with 1,000 shares will be received 1,500 bonus shares which calculated as (1000 x 3/2 = 1500).

Why Issue Bonus Shares?

The purpose of the company issue bonus shares is to increase the active trading by increasing the number of outstanding shares in the market through a reduction in market price per share to a reasonable range.

The companies can increase their stock liquidity and promote more active trading of the shares. It also incentivizes the new investors to purchase the company shares that are performing well within an attractive price range. It will also help the company to avoid the outflows of cash in the form of dividends.

Right Issue

Right share is for the existing shareholders who have the privilege but not obligation to purchase the specified number of shares directly from the company based on the proportion of existing holdings at a discounted price within the specified period. The rights are transferable. Therefore, the shareholders can decide on himself whether or not to buy or even sell off his rights in the open market to other investors by wholly or partially.

The right shares issued to the shareholders have values that used to compensate the current shareholders for future dilution of their existing share’s value. Dilution will occur when a rights offering spreads a company’s net profit over a more extensive number of shares. Thus, the company’s earnings per share (EPS) will decreases as the allocated earnings result in share dilution.

Let us look at the example of the right issue. If the company give out a 1:4 right issue means that an existing investor can purchase 1 extra share for every 4 shares which already held by him. The issued price usually will be lower than the prevailing market price of the stock, which means that the share is to offer at a discount to the current market price.

Why Issue Right Shares?

A Right Issues is carried out by a company to raise additional capital. Companies will use the cash to acquired assets, takeover, corporate expansion or repays their debts. However, the company also can raise money by other ways, such as obtain a loan from a bank. There will be times when the banks are reluctant to lend, the rights issue will be an option. Besides, there will be a high interest incurred by the loans, which may force the company to raise the capital through the right issue of offerings to clear the credit. Therefore, investors need to make investment decision whether or not they want to take up the right issue.

Bonus Issue Vs Right Issue

 

Basis Comparison Bonus Shares Right Shares
Meaning Shares issued in the proportion of their existing holdings Issued to existing shareholders at a discounted price within a specified period

 

Price Issued at free of cost Issued at a discounted price

 

Objective Issued as an alternative to the dividend payment. Also used to bring the market price per share, within the lower price range Raise fresh capital from the market

 

Paid Up Value Always fully paid up Either fully or partially paid up

 

Share Price Shares dilution will bring down the share price in a short period and investors most of the time will not gain nor lose anything. Shares price may plunge due to shareholders will sell the rights to the open market which in discounted price. It also sends the signal to the market that the company may be in trouble so need to find new capital.
Minimum Subscription Not Required Mandatory

Conclusion

Both Right Shares and Bonus Shares have few similarities which offered to the existing shareholders as a tactic that company use to increase the number of their shares in the market.

Written by Stella Goh | 28 November 2018.

2 Thoughts on “Understanding on Bonus Issue Vs Right Issue

  1. chiew keong on December 13, 2018 at 9:06 am said:

    when issue bonus or right, will it adjust the share price to be lower?

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Site last updated July 19, 2019 @ 6:38 am; This content last updated November 28, 2018 @ 7:06 am