Stock Split, Bonus Shares and Share Buyback

All of us are hearing the technical words like Stock Split, Bonus shares, Share buyback etc in the media. As investors, we must have an idea on how such actions will affect our financial life. Please read on to know more about such actions.

Stock Split

Suppose a company XYZ has a share capital of 1000 crores, divided into 100 Crore shares of face value Rs. 10/-.Let us assume that the market value of these shares is currently 2200 per share. The company has decided to split the share to make the face value into Rs.5/-. Let us see what way it will affect your holding of 100 shares in that company.

When the management splits the shares, the face value reduces to Rs.5/-. It will double your number of shares to 200, but the market value of the share will reduce to half making your total value the same.

Stock split will not affect your investment much, but it will increase the liquidity in the stock. This is because, with the reduction in prices, the stock will become affordable to many more investors. This will attract many more retail investors also. There is no tax implication in stock split. The long term capital gains for split shares are calculated from the date of purchase of the original shares.

Bonus Shares

Sometimes, companies reward shareholders with bonus shares. A 3:1 bonus issue means you will get 3 shares for every one share held. In the above example, if you are having 100 shares, you will get another 300 shares!

But don’t think that your investment will become 4 times with these 400 shares. The share price falls on the issue of bonus shares and your total value will be more or less the same, before and after the bonus issue.

The cost of bonus shares is zero. They qualify for tax exemption 12 months from the date of issue, irrespective of the duration for which you have held the original shares.

Bonus shares increase the liquidity of the shares and will attract investor’s interest.

Share Buyback

If a company wants to delist its shares or if the promoter wants to avoid any hostile takeover by increasing his stake, it offers to buy them back from the share holders. Usually such offers come with a good premium to the market rate to attract existing shareholders. Normally share price will shoot up temporarily on the news of share buyback. But this hype will be temporary and if you enter the stock at a higher price, you may lose money.

If you sell shares to the promoter, the transaction is not routed through a stock exchange and there is no securities transaction tax paid on it. So, the short term capital gain will be added to your income and taxed as per your tax slab. The long term capital gain will be taxed at 10% without indexation or at 20% after indexation.

As the number of outstanding shares is reduced, the EPS will increase after the share buyback.

Don’t get carried away on hearing that a company has declared 500% dividend on its shares! Please note that the dividend is declared on the face value of the shares. So, a 500% dividend on a share of face value 10 will be Rs.50/- only. But if the market value of the share is 2200/-, it translate into a dividend yield of 2.27% only!

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