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Monday, October 26, 2009

All about bonus shares in stock markers/why company gives bonus shares/shareholders benefits of bonus shares

Nothing excites retail investors and the media more than news on bonus shares. And this is what happened last week when Reliance Industries issued 1:1 bonus. While some described it as a trick to shore-up investors support—for the stock has underperformed the broader market in the current rally—for others it was company’s commitment to its shareholders.

The Dalal Street, however, has remained cool to the development. At close of Friday’s trading, the stock was trading at the same price as on the day of bonus announcement. But then the question remains, does bonuses really matter? Does the issue of additional shares make any material impact on the company’s share price or its growth prospects?

Lets’ first understand the origin of bonus itself . Every company is incorporated with a paid-up equity capital, contributed by the promoters. This equity capital, which can also be termed as seed capital is divided into units or shares whose face value can be Rs 1 or more. So, if a promoter has contributed say Rs 100,000 to the company’s equity capital, the company will issue him/her 10,000 shares with face value of Rs 10 each.

When a company begins to earn profits, the retained profits (the part of the post tax net profits not distributed to shareholders as dividends) gets added to the company’s equity capital and raises its networth, which is the sum of paid-up capital, retained profits and share premium if any. As time goes by and retained earnings keeps piling up, the net worth rises.

As is evident the issue has not made any material impact on TCS share price (adjusted for bonus). In last five months, TCS stock has appreciated by 115% and beaten its close rival Infosys and the broader market, but it has lagged behind Wipro and HCL Tech, which have gained by 113% and 191%, respectively, during the period.

Even, TCS out-performance vis-à-vis Infosys and Sensex is attributed to its better growth prospects and the fact that the company raised its dividend payout by nearly 33% in FY10. During the first quarter, the company paid a dividend of Rs 2 per share (on an expanded equity) compared to Rs 3 during the same period last year. So if somebody was holding 100 shares of TCS before bonus, he/she earned a dividend of Rs 400 (Rs 2x200) in June quarter compared to Rs 300 in June ‘08. But as you see, it didn’t enable it to beat peers with better growth prospects.

At the end of the day, the share price is determined by a combination of networth (i.e. past earnings record), future growth prospects and its dividend paying record. Any development that leave any of these variables untouched is at best a white noise with no real relevance.

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