Not all bonus issues are good news

BONUS share issues are usually viewed positively. Investors welcome them and companies always present such issues as efforts to reward shareholders. And there have been no shortage of bonus issues on the Singapore Exchange (SGX) in recent months. At least a dozen or so SGX-listed companies have announced bonus issues, according to filings with the stock exchange.

However, like most things, bonus issues aren't always all that they are made out to be.

A bonus issue refers to the issue of new shares to existing shareholders at no cost and in direct proportion to their existing shareholdings in the company. So in a 1-for-4 bonus issue, for instance, shareholders get one new share for every four existing shares they hold.

Because bonus issues are free, it is well understood that they do not directly benefit the company. This is unlike rights issues (where shareholders pay for rights shares at a discount to the market price) which raise funds for the company. Bonus issues also do not materially alter the balance sheet of a company. They are normally done using the retained earnings of a company and involve a book entry transferring an amount from retained profits to share capital. This is also known as the capitalisation of reserves.

But do bonus issues really benefit shareholders, as companies make them out to be?

This is debatable. It can be argued that, theoretically, a bonus issue brings no additional benefit to the shareholder.

While it is true that the shareholder would end up with more shares at no cost, the share price would - theoretically at least - also adjust downwards accordingly to what the market calls the theoretical ex-price. Issuing bonus shares also has the effect of diluting earnings per share.

One way shareholders would benefit from a bonus issue is when the adjusted lower share price makes the stock more affordable and encourages more investors to invest in it. This would result in more liquidity and potentially more upside for the share price.

This would be what companies want shareholders to believe, and indeed, is the rationale given in every bonus issue announcement. Such an outcome is not a given, however, and the share price performance depends not just on having more shares in issue but on a host of other factors.

There are, in fact, some hidden dangers in bonus issues.

For one, companies may be making bonus issues in lieu of dividends. So while getting more shares at no cost, shareholders may be forgoing cash dividends. In some cases, like when a company needs to conserve cash to expand its business, there are sound reasons for a bonus issue in lieu of dividends. But this does not apply to all situations, and shareholders should ask if a bonus issue is masking the lack of dividends when these should be forthcoming.

Another danger is when a penny stock makes a bonus issue. While there may be a good reason for a high-priced stock to make a bonus issue to improve affordability and boost liquidity, it's harder to apply this logic to penny stocks which are already affordable in the first place. So if a penny stock becomes even cheaper, it may pull in speculators rather than long-term investors. Indeed, institutional shareholders - which companies value - are known to shun very low-priced stocks. Attracting speculators and the syndicates may boost the share price in the short term, but if this comes at the expense of having serious investors as stakeholders, it could ultimately curb the upside potential of a stock in the long term.

The other thing to watch out for is when recently listed companies make bonus issues. Companies often say they are rewarding shareholders' loyalty when they make a bonus issue. For a newly listed company, however, there really is no shareholders' loyalty to speak of. So the motives a company has in making a bonus issue in such a situation should be questioned.

Of course, there are many bond fide bonus issues made by companies which are doing well, are confident of their future prospects and are genuinely seeking to reward shareholders. But investors should not see all bonus issues as good news. There may well be a sting at the end of the tail.