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Reliance 1:1 Bonus and the Brouhaha

Reliance, after years of ignoring shareholder demands, has finally decided to give that 1:1 bonus. Last year, they quoted large investors as being concerned about the accounting implications, which is why they ditched announcing a bonus. But this apparently didn’t exist this year. My personal feeling is they waited so the RPL merger would be complete, and then announced it.

So is the big brouhaha warranted? For most investors it makes ZERO difference. The share price will come down by half, and the number of shares will double, on the announced “ex-date”. That means your net worth does not change. With the shares priced lower, it might become more affordable so liquidity *may* increase – but with a company like Reliance which is already hugely liquid, there shouldn’t be any impact.

Does it matter to the company? No. Whatever is being distributed as “bonus” shares is simply a recapitalization of reserves. (Read “Of Shares, IPOs And Stock Markets” for background) Reserves are created by accumulation of profit (whatever is left over after paying dividends). For Reliance this is a HUGE amount – since they have been immensely profitable over the years. They can even give a 10:1 bonus and still have reserves left over.

(RIL has over 100K crores – a trillion rupees – in reserves, with only about 2000 cr. as the face value of equity shares. Some of it has complex implications with debt and FCCBs but there is a HECK of a lot left over)

A lot of people think a “bonus” is a good thing. It’s no big deal at all, in companies like Reliance, unless they were to do a 1:5 split or something bringing the price below Rs. 500 (then a lot more people get interested, for some reason). It used to be a tax saving scheme but even that’s been plugged now. Some say this will increase dividend – but by and large, dividend yield remains constant (so it’s more a function of the stock price, not the number of shares outstanding) Reliance is paying Rs. 13 per share dividend this year. Next year, they might not pay more than Rs. 6.5 per share (unless they increase profits a lot), so income remains the same.

The company made Rs. 105 per share last year which, after the bonus issue will be Rs. 52.5 per share; the current share price at Rs. 2100 discounts past earnings 20 times, and I expect a post bonus price of about 1050 to 1100 per share. The word ‘bonus’ is very positive to hear, but like most things in the financial world, things aren’t as great as they sound.

  • Bingo says:

    >For investors, especially small investors, bonus does matter a lot. The price of a RIL share had crossed Rs. 2000. Suppose someone wants to price-average into a few stocks. His monthly exposure to RIL is Rs. 750. Since he can't buy a fraction of a share, he will have to buy once every 3 months. This reduces the granularity of price-averaging and makes it riskier for the investor.

  • venkat says:

    >When you said "For Reliance this is a HUGE amount – since they have been immensely profitable over the years. They can even give a 1:10 bonus and still have reserves left over", I think you meant to say 10:1 bonus.

  • Sachin says:

    >Hi Deepak.

    I'm a new follower of your blog the last few months and I really appreciate your articles!

    This one was very nice… and it also led me to another nice (older) article on "Of Shares, IPOs and Stock Markets".

    1) I have a query on what you said here:
    'The share price will come down by half, and the number of shares will double, on the announced "ex-date"'

    Will the face value of the share become half or are you talking about market price? If you meant market price, the price being driven by market, how can you say that it will halve?

    2) And also, how will a 1:5 bonus be better for a current share holder than a 1:1 if the market price would then be 1/5th?

    Thanks

  • Deepak Shenoy says:

    >Bingo: agreed, for a very small investor perhaps. At 750 bucks a month the commissions will kill him!

    Venkat: Yes of course – a 10:1 meaning 10 shares for every 1. Mistake,shall correct, thanks for noting.

    Sachin: Market price – it comes by half by the market itself, on the ex-date. You can check every single share also – in fact even the fat-finger price limits are set on that day according to the half price (plus all strike prices of options are halved while lot sizes are doubled etc.)

    5:1 is better only because teh stock becomes moer affordable, which helps small investors in certain stocks where liquidity at the retail level is a problem.

  • Gharoa Adda says:

    >Hi Deepak,

    Refer the blog you wrote regarding Bonus Stripping. I found the following :

    What you propose to do is typically known as bonus stripping. You may note that there are some restrictions in Section 94(8) to prevent tax avoidance through bonus stripping.

    (a) any person buys or acquires any units within a period of three months prior to the record date;

    (b) such person is allotted additional units without any payment on the basis of holding of such units on such date;

    (c) such person sells or transfers all or any of the units referred to in clause (a) within a period of nine months after such date, while continuing to hold all or any of the additional units referred to in clause (b),

    then, the loss, if any, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.]

    definition of "units" doesn't include shares.

    (b) “unit” means unit of a mutual fund specified under clause (23D) of section 10 or of the Unit Trust of India;

    This Section, however, would only apply to units of mutual funds and would not apply to transactions in shares. The transaction as stated by you, therefore, appears to be quite legitimate with no provision prohibiting the same.

    The capital loss that you book on the sale of the original shares, which is a short-term capital loss would be available for adjustment against short-term capital gain on sale of property in the same year.

  • Vikas says:

    >I agree with the article completely that the share price will reduce to half. However, when I check the closing stock price from 1st Oct thru 20th Oct this is not case. RIL made the announcement on 7-Oct. The question is why the price has not reduced to half?

  • Deepak Shenoy says:

    >Gharoa Adda: thanks – that's useful. Didn't know bonus stripping was not applicable for stocks, so there is a use for it, I guess!

    Vikas: the ex-date has not yet been announced. Meaning, the bonus has not yet been given (only said they will do it, don't know when). On the "ex-date" the share will halve.

    But the way it's going it seems to want to go down to half of it's high anyway!