A Beginners guide for novice investors -3; Know about Bonus share and right share
We had discussed the Further Public Offering and Secondary market in our previous articles.
In this article, we will know about the Right shares and bonus shares.
1) Bonus share:
Bonus shares are additional shares that are given to the existing shareholders without any additional cost. In layman words, if the company announces to distribute bonus to its shareholders than those shareholders whose name are recorded at the time of book closure for bonus purpose are eligible for bonus shares. The shareholders are not liable to pay any cost for bonus shares. Such shares are issued to the existing shareholders in the proportion of share they own. The company generally issue bonus out of profit or reserve. For instance, if x company issue 2:1 bonus shares and the book closure for the right issue is Falgun 20, 2074 then the existing shareholder name ‘A’ owning 100 shares at the time of book close will be eligible for 50 shares bonus.
Well, we might be in a dilemma if we don’t pay for the bonus then who does? Though bonus share doesn’t cost to the shareholders, bonus shares are not free. Companies generally don’t distribute their entire profit to the shareholders as a dividend. A fairly large part of the profit is retained and accumulate each year. This accumulated profit in the form of free reserves is used by the company to distribute bonus to its shareholders. After the bonus issue the equity of the company dilutes, the number of shares increased which results in a decrease in the Earning per shares.
In case of bonus shares, the price of that stock should be adjusted. Price decreased by the proportion of the bonus issue. The formula used to adjust the price is:
Adjusted price = Market Price of stock before book close / (1+ Bonus share %)
Lets say X Company announces 2:1 bonus share which is 50% bonus share. The last traded price of X Company before book close was Rs 820. Then:
Adjusted price = 820 / (1+0.5) = Rs 546.67 per share
You can use the bonus shares adjustment calculator for the price adjustment.
Click the link for the calculator:
2) Right share:
The privilege of additional shares which are provided to the existing shareholders in the proportion of share they already own is right shares. This is also one of the most common ways to raise capital by the company. The company issuing right share announces the book closure date for right issue, shareholders owning share at this date will be eligible for right share and they have to ask for right share before the expiry of the specific date.
The shareholder has to pay the additional cost for right shares which can be cheaper than its market price. In the context of Nepal, shareholders have to pay Rs 100 par value for every right share. The benefit of the right issue is to have great control on the existing shareholders, but due to the increase in a number of shares, there is a dilution of the value of shares.
Let’s make it clear with an example, suppose X Company announces (2:1) 50% right share to its shareholders through its board meeting. After the approval from the AGM and from the appropriate authority, the company announces the book closure date. Every shareholder holding the share before the book close will be eligible for applying right share in the proportion of their holding.
In case of right issue also the price of that stock get adjusted after the book close. The formula use to adjust the price is:
Market price of share before right issue + (subscription price per unit *Right %)
Adjusted price = ______________________________________________________
Suppose Y Company announces 2:1 right share to its shareholder and the last traded price before the book close was Rs 820. Then:
Adjusted price = 820 + (100*0.5)
______________ = Rs 580 per share
You can use the Right shares adjustment calculator for the price adjustment.
Click the link for the calculator:
For the purpose of investing, while choosing the stock to choose the stocks which provides bonus shares rather than right share. The reason is that in case of bonus share company utilized its reserve to provide bonus whereas in case of right extra investment should be done by investors for right shares.
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