Perhaps you have heard or read about a company deciding to do a stock split or issuing bonus shares, and you wonder why they do so as opposed to paying cash dividends? On the other hand, you might be confused as you think this is a weird way for a company to reward its shareholders since they are of the same concept. While there are no additional cashflows to the company for either a bonus share issue or a stock split, there are a few reasons as to why these two differ.
Bonus share issue is an alternative method for a company to pay cash dividends. Companies with low cash balance may choose to issue bonus shares rather than paying cash dividends as one of the methods of providing return to shareholders. As such, the company can redirect cash flows in the company for business growth and acquisitions. Bonus share issue is effectively a company capitalising its profit, and often enhances a company’s creditworthiness and brand value. What this means is that the profits earned by the company over the years will now pass to the shareholders as capital investment on paper. This is often taken as a positive sign as the company is confident about future profitability and continued better prospects.
Although share price for a company generally drops after a bonus share issue as more shares are introduced into the stock market, but as a shareholder, you own more shares which will benefit in terms of capital gain/appreciation or increased dividend income in the future. Bonus share issues are done without any cost to the shareholder and will be issued in proportion to a shareholder’s existing holdings. Thus this will be ideal and beneficial for long term investor in terms of taxation, as the investor/taxpayer do not pay taxes upon receiving the bonus shares (unlike dividends), but only when they dispose of it.
Stock Split, as the term suggests, is when companies split their shares. A simple analogy is like exchanging a $20 bill for two $10 bills. A stock split will mean an increase in number of outstanding shares, with the total market capitalisation for the company remaining the same. This is usually done to increase the liquidity of shares and lower share price to make it more accessible for retail investors. As an investor, it’s basically a draw for you as your total investment remains the same. Not only do small and mid-range companies go for stock split, blue-chip companies do this too.
As a company grows from launching new products or increase in growth acquisition, the quoted market price of the stock sometimes becomes too expensive for investors which will adversely impact the bid and ask prices. For example, had Apple never split its stock, it would be traded at roughly $28,000 per share. If the gap between the ask and bid price widens excessively, there will be less trading in the market as it may be harder for investors to trade. While share price will evidently fall, know that this is not a financial event and there are no changes to the underlying fundamentals of a company.