Two of the more common adjustments you will see with equity capital are splits and bonuses. While typically a source of investor excitement, I think an understanding of what actually happens will help you decide whether that excitement is justified.
To put it very simply, a share split occurs when a company reduces the face value of its shares while at the same time increasing the number of shares outstanding. I think this will be easy to understand if we take the example of Relaxo Footwear
The company announced a split of its shares from the old face value of Rs 5 to rs 1 in 27-07-2013, and the ex-split date was 22-11-2013.
The number of shares outstanding will be multiplied by 5 and the face value will be divided by 5.
Before Split Share Capital: 1,20,01,200 shares * Rs 5 = Rs 600.06 lakhs
Post Split Share Capital: 6,00,06,000 shares * Rs 1 = Rs 600.06 lakhs
In order to compensate for the increased number of shares outstanding (5x), the market price of the share is adjusted (divided by 5) to keep the market capitalization the same. Check the share price on 21st November and 22nd November 2013 to verify this.
Share splits can increase the liquidity of a stock, but they have no impact on the fundamentals of the business. Suppose somebody took a Rs 10 note from you and handed you two Rs 5 notes. Would that make you richer?
Note: A reverse-split is the exact opposite of a share split, where the face value is increased while decreasing the number of shares outstanding proportionately.
A bonus issue occurs when a company issues fresh shares to existing investors in a certain proportion to their existing shareholding. According to SEBI guidelines, a company can only issue bonus shares out of reserves created from genuine profits. Lets take the case of Infosys to understand what happens in a Bonus issue
If you check the latest annual report – there are two things to note
(1) The company in December 2014, had issued bonus shares to the shareholders of the Company in proportion of 1:1 and consequently, the paid-up share capital of the Company increased from 57,42,36,166 to 1,14,84,72,332 shares (Page 12). At a face value of Rs 5 per share, this works out to Rs 287 crore (57,42,36,166*5)
(2) Where does that money come from? Correspondingly, the AR mentions that the security premium account is reduced by Rs 287 crore to account for this (Page 57)
Do note that the company also increased its authorized share capital so that it could go through with the bonus issue. The company’s bonus issue was reflected on 2nd December, 2014 (ex-bonus date), where the market price of the company was halved to account for the bonus issue. The company has issued a second bonus since then, you could work out the details as a followup exercise.
In both cases, the number of shares outstanding changes, but while the share split changes the face value of the share and keeps the issued & paid up capital same , the bonus share keeps the face value same while changing the issued share & paid up capital base.
The bottom line is that share splits and bonuses don’t change your percentage ownership of the business in which you own shares, nor do they make you wealthier in any real sense. The fundamentals of the business are what will dictate value in the long run and contribute to wealth creation.