Important Question

[shsaeed]

Please Give Me Answers of following?
1> Will the price change after a bonus issue?
2> Bonus shares vs. Stock split


thanks

Sheikh Asim Saeed

[kamranACA]

Dear Asim Saeed,

BONUS SHARES' AFFECT ON PRICING

Share pricing varies in markets due to a number of reasons. On declaration of bonus shares number of equity shares will increase and as a result EPS comes down and so the PE ratio because stock will look relatively costly at present P/E ratio so price comes down and it burdens the company in terms of generating previous level of earning since outstanding shares increase and with same level of topline growth, the company it cannot generate same EPS.

However, merely bonus shares cannot be called the major reason for the fall of share value due to number of other factors in the market. The dividend pay out ratio and dividend sharing ratio among the existing shareholders normally remains un-affected to a great extent, (if bonus shares are not traded in the market in shorter period) therefore, the prices are not extremely affected by the issue of bonus shares. So much depends upon market's behaviour, demand supply forces and bullish or bearish trends, therefore, in my view bonus share can to some extent affect the pricings but in the long-run such influence normally proves to be insignificant becoz the company retains the cash resources by substituting the dividends by bonus shares. The retention of cash resources within the company increases working capital and fortfies the equity and capital maintenance of the company. DUe to these reasons bottom line results improve in longer run and prices come bak to existing lvel or increases due to growth in business and profitablity in longer run. However, if dividends are also paid with bonus shares or are paid in shortly subsequent periods, this will not happen and EPS will remain down resulting lesser PE ratio and lesser market price. In the short run, bonus issue does affect the prices unless some miracle occurs which boost up the bottomline results and EPS despite the dilution caused by issue of bonus.

STOCK SPLITTING AND AFFECT ON PRICING

When a company declares a stock split, the price of the stock will decrease, but the number of shares will increase proportionately. For example, if you own 100 shares of a company that trades at $100 a share and it declares a two for one stock split, you will own a total of 200 shares at $50 a share after the split. A stock split has no effect on the value of what shareholders own. If the company pays a dividend, your dividends paid per share will also fall proportionately.

Companies often split their stock when they believe the price of their stock exceeds the amount smaller individual investors would be willing to pay for the stock. By reducing the price of the stock, companies try to make their stock more affordable to these investors.

Although many stock splits are two for one, companies can split their stock in any number of ways, including three for one, three for two, and so forth. A stock that has split in the last 52 weeks will be identified in newspaper stock columns with an "S" next to the company's name.

Stock split refers to a corporate action that increases the number of shares in a public company. The price of the shares are adjusted such that the before and after market capitalization of the company remains the same and dilution does not occur. Options and warrants are included.

Take, for example, a company with 100 shares of stock priced at $50 per share. The market capitalization is 100 × $50, or $5000. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. The market capitalization is 200 × $25 = $5000, the same as before the split.

Ratios of 2-for-1, 3-for-1, and 3-for-2 splits are the most common, but any ratio is possible. Splits of 4-for-3, 5-for-2, and 5-for-4 are used, though less frequently. Investors will sometimes receive cash payments in lieu of fractional shares.

It is often claimed that stock splits, in and of themselves, lead to higher stock prices; research, however, does not bear this out. What is true is that stock splits are usually initiated after a large run up in share price. Momentum investing would suggest that such a trend would continue regardless of the stock split. In any case, stock splits do increase the liquidity of a stock; there are more buyers and sellers for 10 shares at $10 than 1 share at $100.

Other effects could be psychological. If many investors believe that a stock split will result in an increased share price and purchase the stock the share price will tend to increase. Others contend that the management of a company, by initiating a stock split, is implicitly conveying its confidence in the future prospects of the company.

In a market where there is a high minimum number of shares, or a penalty for trading in so-called odd lots (a non multiple of some arbitrary number of shares), a reduced share price may attract more attention from small investors. Small investors such as these, however, will have negligible impact on the overall price.

When a stock splits it is shown on many charts similar to a dividend payout. But what is not shown is that when a stock splits it does not show the dramatic dip in price. Taking the same example as above, a company with 100 shares of stock priced at $50 per share. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. Based on this example you would expect that you would see the stock dropping 1 day from $50 to $25. This would cause chaos in the market as investors would panic if they did not take time to realize that there was a stock split. So what is done is something called adjusted close price. This adjusted close price will take all the closing prices before the split and divide them by the split ratio. So when you look at the charts it will seem as if the price was always $25.



DIFFERENCE IN BONUS ISSUE AND STOCK SPLIT

At first flush, they may appear to be the same especially in the eyes of a person not well-versed in finance. But there are fundamental and visceral differences. When a bonus issue is made, the company's share capital is increased with a concomitant decrease in its Reserves and Surplus. But when a share is split, say, from Rs 10 denomination to Re 1 denomination, there would neither be an increase in the share capital nor a concomitant decrease in the reserves of the company.

This is because while in a bonus issue a person having one share of Rs 10 face value would get another share of the same face value should the company go for a 11 bonus what would happen in a stock split is his one Rs 10 share would now be converted into ten Re 1 shares.

Stock split may, therefore, appear to be more illusory than bonus issue. But it does make the shares more affordable in the market. For example, if a Rs 10 share is quoting at Rs 1,200 per share, this may deter investors from buying the same but if it is split into 10 shares then theoretically a Re 1 share quoting at Rs 120 may not frighten away potential investors.

While a decision as to stock split does not have many imponderables, a bonus issue is fraught with grave implications, involving as it does permanent increase in the capital with implications for future serviceability of the enlarged capital in the light of market expectations.

Best regards,

Kamran.

[Astute Accountant]

Wow Kamran Bhai what a stamina to explain in such a detail........

[kamranACA]

Thank u. I get all my info from guys like you my friend. No body knows anythinh unless he/she learns it. And fellow humans are best source to learn.

Regards,