There are a myriad corporate actions that shareholders should know – Rights Issue, Stock Splits, Bonus Issue, to name a few.
It can be quite daunting to understand all these terms for the part time DIY investor. I know this because my uncle and auntie have showed me such circulars to get my help to understand them when I was much younger. They didn’t know English and thought that I would be able to decipher it for them because I was learning English in school. But kid you not, I did not know what the letters meant despite reading them over and over again. Knowing English is not enough, it doesn’t give you the ability to understand financial reports and letters. Only financial literacy does.
Sometimes I cannot help but think that the financial industry is created to leverage on the gap in financial literacy, so that those who know, can rip off those who do not.
We will discuss the common corporate actions over a few articles. This article will focus on Bonus Issue.
What Is A Bonus Issue
A bonus issue, to put it real simply, is free shares for existing shareholders. For example, it would usually be stated as 1 bonus share for every 10 existing shares. If you have 1,000 shares, you are going to receive 1,000/10 x 1 = 100 additional shares. You will end up with 1,100 shares after the bonus issue.
Difference Between Bonus Issue and Rights Issue
Bonus issue is free while rights issue requires shareholders to pay for the additional shares.
There is no reason why a shareholder would reject bonus shares since there is no cost to them. As for rights issue, some shareholders may choose not to subscribe to the additional shares and the percentage ownership would shrink as a result as other shareholders would get the additional shares.
Difference Between Bonus Issue and Share Split
Share splits also do not require shareholders to pay for the additional shares, so what is the difference with bonus issue?
Bonus issue can only be declared when the company has made profits over the years. It usually requires the capitalisation of retained earnings to share capital. What’s that?
It means that shifting the profits earned by the company to increase the capital invested by the shareholders. In other words, passing the earnings to shareholders on paper.
Effect of Bonus Issue
After a bonus issue, more shares will be introduced into the stock market and share price should drop accordingly. For example, in a scenario of 1 bonus share for every 10 existing shares, the share price should drop 10% on the Ex-Bonus date.
The Ex-Bonus (XB) date means you do not receive the bonus shares when you invest in the stock. Cum-Bonus (CB) means you would get the bonus shares when you invest in the stock.
The effect is similar to a stock split and that is why investors get confused about the difference with bonus issue.
Why Do Bonus Issue?
So why does management want to do bonus issue?
More often than not, they will state a reason for proposing a bonus issue. But whether it is the true intent we will never know. As outsiders, we can only make a good guess.
The common reasons are to reward shareholders and / or to lower the share price through the increase in the number of shares so that each lot size would become cheaper to investors.
So… Is Bonus Issue A Good Thing?
I see it as a slightly positive event. Positive because only companies with retained earnings are able to do bonus issue, and they must be confident of the future to maintain the profitability.
On the other hand, a reduced retained earnings would also mean that the company has less amount to distribute dividends. This may not be good news for dividend lovers. I am indifferent as I favour capital gain due to the larger payoff.
I am not particularly bullish because the event does not change the company’s fundamentals. There is no value creation in the process.
Today (13 Apr 2016), Hong Fok, which is listed on Singapore Stock Exchange (SGX), is going XB.
They have announced 1 for 10 bonus issue weeks ago and have got SGX’s approval-in-principle. This action should be approved without trouble in the coming Annual General Meeting (AGM).
Let us evaluate this Issue. Excerpts are taken from the announcement made by Hong Fok.
The Board of Directors of Hong Fok Corporation Limited (the “Company”) wishes to announce that the Company is proposing a bonus issue to its shareholders on the basis of one (1) bonus share for every ten (10) existing ordinary shares in the capital of the Company (“Shares”), fractional entitlements to be disregarded (the “Proposed Bonus Share Issue”).
This is simple. The bonus share is 1 for 10.
The Directors have agreed to issue and allot the Bonus Shares at nil consideration without capitalisation of the Company’s reserves.
This is interesting. “Without capitalisation of the Company’s reserves.” We have expounded that bonus issue usually requires the retained earnings to be capitalised into the share capital. But in this case, Hong Fok is NOT going to do it with this bonus issue. This means that this bonus issue has is equivalent to a stock split. There will be no change to share capital and retained earnings.
On the flipside, not reducing the retained earnings now would give more room for future dividend payments. Shareholders should know that dividends can only be given based on the amount of retained earnings. But given Hong Fok’s record of low dividend payments, shareholders should not be hopeful over the dividends.
The Company is considering the Proposed Bonus Share Issue to give due recognition to its shareholders for their continuing support for the Company and to reward shareholders of the Company for their loyalty. The Proposed Bonus Share Issue, if carried out, will also increase the accessibility of an investment in the Company to more investors, thereby encouraging trading liquidity and greater participation by investors and broadening the shareholder base of the Company.
The management has stated their reasons for issuing the bonus shares – to ‘reward’ shareholders and increase accessibility of investment due to a lower share price.
You just need to remember that bonus shares are free and you do not need to take any action. It is usually a positive thing so don’t fret about it.
The share price will drop after bonus issue but please do not think that you have lost money. You got more shares in return so your investment is still worth the same amount. Don’t panic.