this is from the sharemarket school website. i hope it help some...

this is from the sharemarket school website. i hope it help some people.




Bonus shares – A positive sign.
by J Victor on March 29th, 2011

• WHAT ARE THEY?

Bonus shares are issued in a certain proportion to the existing holders. A 2 for 1 bonus would mean you get two additional shares — free of cost — for the one share you hold in the company.If you hold 100 shares of a company and a 2:1 bonus offer is declared, you get 200 shares free. That means your total holding of shares in that company will now be 300 instead of 100 at no cost to you.

WHO BEARS THE COST IF IT’S FREE FOR ME?

You are right. There is no free lunch.Bonus shares are issued by cashing in on the free reserves (accumulated profits) of the company.A company builds up its reserves by retaining part of its profit over the years (the part that is not paid out as dividend). After a while, these free reserves increase, and the company wanting to issue bonus shares converts part of the reserves into capital.So you do not pay; and the company’s profits are not impacted.

WHAT ARE THE EFFECTS OF A BONUS ISSUE?

Bonus shares do not directly affect a company’s performance. Bonus issue has following major effects.

1. Share capital gets increased according to the bonus issue ratio.
2. Liquidity in the stock increases.
3. Effective Earnings per share, Book Value and other per share values stand reduced.
4. Markets take the action usually as a favorable act.
5. Accumulated profits get reduced.
6. A bonus issue is taken as a sign of the good health of the company.

WILL THE SHARE PRICE CHANGE AFTER BONUS ISSUE?

A bonus issue adds to the total number of shares in the market.Say a company had 10 million shares. Now, with a bonus issue of 2:1, there will be 20 million shares issues. So now, there will be 30 million shares.This is referred to as a dilution in equity.Now the earnings of the company will have to be divided by that many more shares.(Earnings Per Share = Net Profit/ Number of Shares)Since the profits remain the same but the number of shares has increased, the EPS will decline.Theoretically,When EPS declines, the stock price should also decrease proportionately. But, in reality, it may not happen.

That’s because:

i. The stock is now more liquid. Now that there are so many more shares, it is easier to buy and sell.

ii. A bonus issue is a signal that the company is in a position to service its larger equity. What it means is that the management would not have given these shares if it was not confident of being able to increase its profits and distribute dividends on all these shares in the future.

THE RECORD DATE.

When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus.

After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.

HOW BONUS SHARES CREATES ENORMOUS WEALTH

Bonus shares, in the long run would create enormous wealth for the investor. For example, a Rs 10,000 invested in Wipro in 1980 would have grown into several Crores as shown below:-

In 1980 You buy 100 shares @ Rs 100 per share in your name . In 1981 company declared 1:1 bonus = you have 200 shares

In 1985 company declared 1:1 bonus = you have 400 shares. In 1986 company split the share to Rs. 10 = you have 4,000 shares

In 1987 company declared 1:1 bonus = you have 8,000 shares. In 1989 company declared 1:1 bonus = you have 16,000 shares

In 1992 company declared 1:1 bonus = you have 32,000 shares In 1995 company declared 1:1 bonus = you have 64,000 shares

In 1997 company declared 2:1 bonus = you have 1,92,000 shares. In 1999 company split the share to Rs. 2 = you have 9,60,000 shares

In 2004 company declared 2:1 bonus = you have 28,80,000 shares. In 2005 company declared 1:1 bonus = you have 57,60,000 shares

In 2010 company declared 2:3 bonus=you have 96,00,000 shares.

Share price of Wipro is Rs 428.00 in July 2010

The value of 57,60,000 shares in 2010 – 406.60 Crores.

CONCLUSION

Declaring Bonus shares is a sign that companies are increasing their profitability. If you look back, many companies have announced issues of bonus shares to their shareholders by capitalizing their free reserves . Shareholders have benefited tremendously, even after accounting the inevitable reduction in share prices post-bonus, since the floating stock of shares increases. So keep an eye on bonus history when you decide to buy a stock-It may be a good indicator that the company is healthy.