Investment is important when it comes to accomplishing one’s financial goals. In today’s world, earning money and keeping it idle in your bank account is equivalent to a lost opportunity. What matters is working hard for the money you earn and invest to get good returns out of it.
One can invest their hard-earned money on shares. Shares are one of the many ways one can invest your hard-earned money. Shares are issued by companies to accumulate the money from investors for the expansion of business. When a company earns a surplus/profit, it issues a proportion of the profit to its shareholders either in the form of bonus shares or dividends.
Bonus Shares vs Stock Dividend
The main difference between bonus shares and the stock dividend is that stock dividends are the payment made by companies to allocate wealth to their shareholders in the form of more shares, on top of those they already own, and not cash whereas bonus shares are the new/additional, free of cost shares issued to the shareholders of the company.
Comparison Table Between Bonus Shares and Stock Dividend (in Tabular Form)
| Parameter of Comparison | Bonus Shares | Stock Dividend |
|---|---|---|
| Meaning | A bonus share is when a company decides to give extra shares to its existing shareholders. | Stock dividend is a part of company profit that the company distributes to its shareholders in the form of cash. |
| Purpose | The purpose of issue of bonus shares is that of increasing the liquidity of the shares of a company, that is, how quickly shares can be bought and sold in the market without affecting its price. | The purpose of stock dividends is to distribute wealth back to the shareholders of the company. |
| Mode of calculation | Bonus shares are decided to be distributed to the shareholders in the form of a ratio. | Stock dividends are decided to be distributed to the shareholders in the form of a percentage. |
| Benefit | Bonus shares provide non-monetary benefits. | Stock dividend is a monetary benefit. |
| Allocation to shareholders | A company can issue bonus shares to its shareholders even when the company has incurred losses and this can be done from the reserves accumulated by the company in the past years. | As per the companies act 2013, a company can pay the dividends to the shareholders only when the company earns substantial profits at the end of the financial year. |
What are Bonus Shares?
Sometimes, the company issues additional shares to its current shareholders based on the number of shares each shareholder owns. These shares are known as ‘bonus shares’. If the shareholders of the company are qualified for bonus shares, it is credited to their Demat account.
Why do companies issue bonus shares?
Sometimes a company may have insufficient funds to pay dividends despite earning profits. In this scenario, the company issues bonus shares instead of dividends to its existing shareholders in addition to their existing holders of shares in the company. Bonus shares are also known as capitalization of profits and are distributed to the shareholders from either the reserves or profits of the company.
Advantages of bonus shares:
Bonus shares are issued by companies instead of paying a cash dividend. The various benefits an investor can receive are as follows:
- It is beneficial in enhancing the faith of the investors and shareholders in the long term growth of the company to increase their investment in the same.
- If in the mere future, the company decides on the payment of the dividends as in the form of cash, the investor will in turn receive a favorable amount for holding a lot of bonus shares.
- Bonus shares satisfy the dividend desire of the shareholders since the company may not always be in a position to pay cash to its shareholders.
- Bonus shares increases the goodwill of the company in the market by creating a good image of the company and its shares.
Disadvantages of bonus shares:
- Some investors may be more interested in liquidity rather than receiving shares to fulfill the various objectives an investor may have. However, selling bonus shares for generating liquidity may reduce the investor’s stake in the company.
- Governing a plan involving bonus shares is more costly than the payment of dividends by cash since shares can accumulate for years if the company keeps on issuing bonus shares.
- The issue of bonus shares is a lengthy process and is often delayed due to the process of obtainment of by the central government using SEBI.
What is Stock Dividend?
Stock dividend is the payment made in the form of shares instead of cash to issue wealth to the shareholders of the company. Stock dividends are also known as scrip dividends.
Advantages of Stock dividends:
- Yielding Income: As an alternative source of income, one can invest in dividends to earn a steady income in the future. For earning income through stock dividends, first and foremost, you need to find good stocks yielding profitable dividends and once this is done, you can yield steady income for many years to come.
- Double profits: If the stock you have invested rises by 40% in the next 4 years, and you have received a dividend yield of 4% per year from the same stock, the profits combined are more than just the capital appreciation. Hence, you gain more profits when you do not preferably invest in companies that give no dividends.
- Dividend Re-investment: Dividends received from stocks can be used to invest in various secondary investment options like bonds, gold, etc which in return can help diversify your portfolio.
- Longstanding investment: Stock dividends offer a steady and long term income. This benefits most investors who favor holding the stocks for a long time and helps reap the benefits of long-term investing.
Disadvantages of Stock dividend:
- The market may declare stock dividends as a shortage of cash or uncertainties in the company. For this reason, the prices of the stocks may fall in the market.
- Dividend cut: A company may decide to cut the dividends anytime in the future. Moreover, when the company cuts the dividends, the share prices intend to fall. The board of directors changes the dividend policy of the company from time to time. This in turn will harm the dividend investors.
- Low-growth companies: Big reputed companies offer a large profit to their shareholders while, on the other hand, many investors may be investing in low growth companies that may not always offer high returns.
Main Differences Between Bonus Shares and Stock Dividend
- A bonus share is rewarding shares given by the company to its existing shareholders. Stock dividends are the payments given by the company, from their profits to their shareholders.
- One of the major purposes of bonus shares is increasing retail participation as well as the liquidity of the shares. The major purpose of stock dividends is to benefit the shareholders of the company by returning his wealth to him.
- Bonus shares are distributed to the shareholders of the company based on a ratio. Stock dividend is distributed to the shareholders of the company based on a percentage that is eventually decided by the company itself.
- Bonus shares are a non-monetary benefit/reward to the shareholders of the company in addition to their existing holders of shares. Stock dividends are considered as a monetary benefit to its shareholders and it is given as per profit earned by the company.
- Bonus shares can be issued to the shareholders of the company even when the company has incurred losses and this payment can be made from the reserves of the company. As per the Companies Act, 2013, stock dividends are paid to the shareholders only when the company earns enough profit at the end of the year.
Conclusion
Investments ensure safety, growth, and income to an individual. Even though each investment has its own unique set of benefits and risks, it highlights the importance behind how they help most individuals acquire wealth, fund retirement, and accumulate savings and businesses to make the most out of their profits and earnings.
Many inexperienced investors may be unfamiliar with certain financial terms under the topic of dividend investing, such as, stock dividends or may even be intimidated by it. Therefore, this article aims at clarifying some basic term definitions, benefits, and restrictions of stock dividends to assist the investors in making the right choices when it comes to investing in the stocks and shares of a company and the best returns on such investments.
This article also briefs us about how it is a good idea to buy shares from superior companies, who have announced their issue of bonus shares, by discussing how it is a positive sign to the market that the company is doing good in its long term growth along with the advantages and disadvantages a bonus share can bring to an investor.
References
- https://dspace.stir.ac.uk/bitstream/1893/9747/1/Stock_market_reaction_to_bonusissues_in_Nigeria.pdf
- https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1475-6803.1983.tb00306.x
- https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0507/0507003.pdf