What is a bonus issue?
Bonus shares are additional shares given to current shareholders of a company, at no extra cost. The issue will be in proportion to the number of shares currently held on the record date. Market capitalisation remains the same, but the number of shares increases. Thus, the price reduces in the same proportion. Face Value (FV) of the stock remains the same after a bonus issue.
Eg: Assume an investor holds 100 shares of a company. After a 2:1 bonus issue, he will get 2 bonus shares for every 1 share held. Hence, he will have 300 shares (100+200).
Why a bonus issue?
Companies issue bonus shares to stimulate retail demand and to reward existing investors. The price of a stock reduces after a bonus issue, and hence more retail investors are likely to participate.
How does it work for an investor?
Bonus shares are issued at a price of Rs 0, hence the value of your holdings is reduced in the ratio of the issue. Market price also changes accordingly.
If you have 1 chocolate, imagine you get 1 for free. The face value does not change.
Where does the money come from?
Bonus issues are accumulated earnings of the company which are converted into free shares. Since face value does not decrease like in a stock split, an issue reduces the reserve capital of the company.