By Ruma Dubey

A company mired in legal litigations and losses could one day suddenly zoom into the stratosphere, scaling new highs, a drastic change from its habitual low levels. This sudden change in mood could happen only on two counts – if the company has announced profits or if it declares a stock split.

And a company which is already doing well, could scale newer heights, the moment it announces that its Board is meeting to discuss the bonus ratio.

In both cases, the moment the news is announced, stock scales new highs and after the actual ‘happening’ of the event, the price slips, almost halves. So what should one back – stock split or bonus?

For that first understand the fundamental difference between the two. A stock split, as the name suggests, splits the face value of the stock – a rs.10 face value stock is split into Rs.2/share. This means, after the split, from holing just one share of Rs.10/each, you will be holding 5 shares of Rs.2 each. There is no change in the equity capital and market cap – only thing which changes is the public float. The aim of the stock split is essentially to increase liquidity, increase participation. Thus as an investor, though the share price decreases, equivalent to the stock split, post the split, the number of shares one holds increases. The lower price is what is expected to bring in more investors.

Bonus shares are essentially that – bonus, a reward for good performance. Here too, post bonus, the number of shares held by a shareholder goes in the proportion of the bonus declared but along with that equity capital and market cap also rises. Face value remains the same. Like a 1:1 bonus means, if you held 100 shares, your holding post the bonus will rise to 200 shares and the stock price will slip ex-bonus, adjusting to the 1:1 ratio, addition of new shares. That reduced stock price is then the true value of the stock.

For a trader, both are good news as it gives him an opportunity to ride the high wave. But for an investor, what is good, stock split or bonus? The answer is straight forward – obviously the bonus candidate. The first is reason itself  - a stock split does not necessarily mean that the company is doing very well; a stock split is sometimes announced to prop up the stock price in dire times. So stock split is in no way a reflection of the fundamentals of the company.

On the other hand, the bonus issue does mean that the company is doing well and that automatically means good fundamentals. Thus for an investor, it is fundamentals and fundamentals alone which will take him to profits.

Also remember, dividend is declared on the face value of the shares; so a split stock’s dividend in hand goes down unlike that in bonus shares, where you tend to earn more.

Another big advantage is in terms of taxation. Bonus shares are known as “free” shares. And this does not mean merely getting the free shares, it also means from the taxation angle. Bonus shares are treated like any other share when it comes to computing taxes. You pay tax when you sell them at a profit – short term tax when sold before 12 months of getting it. But if you sell if after a year of getting it, there is no tax on the gain. For calculating profit on bonus shares, the cost is always considered as zero and thus ‘free’ shares.

You can use bonus shares to save taxes – when the share price drops ex-bonus, one can sell the original shares and book notional loss, offsetting it against short term capital gains tax. You anyway have the bonus shares, which you can hold on for more than a year and then sell to earn a profit without tax.

On the other hand, when it comes to stock split, the tax outgo actually comes down, once again if sold before one year. If you held 100 shares at Rs.300/share, after split, you will hold, say 200 shares which means your cost has come down to Rs.150/share. Thus the tax will be paid on purchase price of Rs.150 and not the original cost of Rs.300.

Be it stock split or bonus shares, what ultimately matters are the fundamentals of the company.  There surely are benefits to be earned due to the price movement but when it comes to stock split, best to always understand the objectives of the split and the long term benefits.

Ultimately, stock price depends on the fundamentals of the company and how it settles down after the split or the bonus. In the long run, stock splits have a neutral effect on the stock price while bonus adds to the capital appreciation. Choose what you want…..