The common mistake that people commit while looking at the stock investment is that they think they can only make money by buying and selling of the stocks. On the face of it, it sounds perfect - buy cheap and sell when the price is high. But there is also a facet of stock investment which can make you plenty of money provided you have a long-term investment perspective. The incentives of having a long-term view are dividends, bonus shares and rights issue. It's true they come at a slow and leisurely pace but wealth creation is a process which takes time. Like intraday trading, you don't see the results in a day's time.
But before we get into how bonus and split shares can add value to your portfolio let's first understand what these phenomena and why companies undertake them.
What Is Bonus Share?
Bonus shares are the extra shares granted to the current shareholders. A ratio and record date is determined by the company and all the investors who own the company's shares on that day qualify to get the bonus shares. Bonus shares, as the name suggests, is a bonus, a reward to the investors from the company. However, there is also a concealed motive of the company behind it. By giving bonus shares the number of fully paid up, outstanding shares increases at the same time the value of the share is adjusted (decreased). As a result, company's stock, with the updated price, becomes attractive to new retail investors. It would be safe to say that bonus share is a win-win situation for the companies as well as for the investors. Remember, in the event of the bonus shares, the face value of the share does not change.
Long-term investors love bonus shares. Not only it increases the stock holding of a particular stock but also gives a chance to the investor to get more upside in the stock. When a company announces bonus shares they announce it in a certain ratio. Once all the formalities are done, the price of the share is adjusted. As a result, when the bonus shares are credited to your account, the average price of the shareholding comes down and there is always a possibility (for good companies) for the share price to go higher in the future. It simply means the stock will bring you wealth.
What Is Split Share?
Splitting shares is an option a company can use if it feels the price of the company's stock has become too big and it no longer looks attractive to the investors. Also, splitting the stock is a safe way to regulate the price without hampering the market capitalisation and the interest of the existing shareholders. All the big companies split their shares on regular basis. Just like in bonus share, the splitting is done with a certain ratio e.g. 1:1 or 3:1. However, unlike bonus shares, when the stock is split, the face value of the share changes.
What Is Rights Issue?
The rights issue is the process by which a company raises further capital. The thing which makes Rights Issue different is that the rights issue is only available to the existing shareholders of the company. For example, if X holds 100 shares of Y company and the Y company rolls out a rights issue with the ratio of 5:1 (For every 5 shares you can apply for 1 share). In this case, X has 100 shares so he/she can apply for 10 shares.
Now you must be thinking why X would apply for the shares in the rights issue when he/she can easily get the shares from the open market? The reason is discount! Yes, in a rights issue the shares are offered at a discounted price.
A Cautionary Note: Like bonus and split shares the announcement of the rights issue is not always received by the investors with a great enthusiasm. The reason being - the rights issue is rolled out in the situation where the company needs additional funds as it doesn't have enough cash to keep the operations going. This shows the company is not handling its cash efficiently thus it casts a shadow of a doubt over the management of the company.
However, if the company is being managed by a good promoter he can get the company back on its feet in no time. Therefore rights issue can also be a golden opportunity to buy shares at discount and bring down the average price.
Good Things Come To Those Who Wait!
You can look at Infosys as the prime example of how a company can make a fortune for its long-term investors. The generous dividend payouts and periodical bonus shares have played a vital role in it. Infosys got listed in 1993 and till date, it has given bonus shares 6 times in different ratios. Those how have been holding the shares of the company through all these events have built a handsome corpus over the years.