bonus shares and value

Bonus shares are quite frequently used by the Indian companies for a variety of reasons. These stock dividends are popular among the investors. 

Recently, one of my friends was talking about how an MNC showered shares after shares as a bonus to the stockholders in the past three decades. Little does he know that those gifts did nothing to the value of his shares.

More recently, the shareholders of TCS were demanding bonus shares at their annual meeting. TCS is the most valuable listed company in India with a market-cap of Rs.5,130 b. 

Not many investors understand that value of a business depends upon its cash flows, growth and the risk in those cash flows. If an event does not affect these, it cannot affect the business value. 

Bonus shares represent issue of additional number of shares to the existing shareholders in a specified ratio by way of a transfer from retained earnings. In other words, it is a book adjustment from retained earnings to share capital. Forget doing anything else, it does not even change book equity. The market price, obviously, adjusts to reflect higher number of shares outstanding. 

If you hold 100 shares with a market price of 50, after an issue of 1:1 bonus, you will end up with 200 shares having a market price of 25. You are not going to be any richer with these additional shares. 

Some companies play games with market through stock dividends or stock splits, just to bring down the market price of a share such that it becomes cheaper (of course only in the minds of investors) to buy and sell. These tactics might temporarily change market price; but the intrinsic value of the business remains unaffected. 

TCS will be well served if it concentrates on its operations rather than distractions such as bonus shares. It could consider stock buybacks if market price is considered a bargain; but is it? It could also consider operating independent of other Tata-group companies. The inter-holdings within the group make an investor wonder about what is going to happen to the excess cash.

In the meantime, investors should try to understand the business behind the stock rather than the stock ticker itself. I am not sure when an Indian shareholder will actually understand the real story behind bonus shares.