Rights issue vs bonus issue: Do they come really as a bonanza?

By DK Aggarwal

Listed companies often reward shareholders through issue of additional stocks or shares through bonus issue and rights issue. There are substantial differences between a rights issue and a bonus issue. Investors need to understand the same so that they do not get confused while taking important investment decisions.

Before going deeper into the differences between the two, let us first look into the descriptions and meanings.

Rights issue refers to that issue in which a company gives rights to their existing shareholders to purchase additional shares in the company at a discounted price to the market price within a stipulated time frame. On the other hand, bonus issues are distribution of the company’s accumulated earnings, which instead of being given out in the form of dividends is converted into additional or free shares to current shareholders in proportion to each one’s stake without any additional cost.

In both the cases, the stock price of the company issuing rights shares and bonus issue gets adjusted after the record date, which is a cut-off date set by the company. For example, a 1:4 rights issue would mean an existing investor can buy one extra share for every four shares already held. Usually the price at which the new shares are issued by way of rights issue is less than the prevailing market price of the stock, i.e. the shares are offered at a discount.

In the case of bonus issue, if the company has announces a 1:1 bonus issue and the stock price is Rs 300, then after a bonus issue, the stock price should logically reduce to Rs 150.

As mentioned earlier, in the case of rights issue, shares are issued at a discounted price, however in the case of bonus issue, shareholders get the shares for free.

It is not compulsory for an existing shareholder to opt for the rights issue. Investors may also get out of the stock before the record date if one is not interested to participate in the right issue. A company comes out with the right issue when it wants to infuse fresh capital into the company. In another words, right shares are a better option for companies for capital infusion than high-interest bank loans. The capital raised through a right issue can be used for business expansion.

On the other hand, bonus shares are issued by a company when it accumulates a large free cash reserve. It increases the goodwill of shareholders and brand perception. In simple words, a bonus issue is made out of the company’s reserves so as to reward its shareholders.

In the case of bonus shares, they come free and shareholders do not need to take any action. So, the question is: should investors opt for a rights issue?

Subscribing to a rights issue offer is similar to akin investing in a company. Investors should never consider a rights issue just because it comes at a discount. Shareholders need to look at other factors such as growth prospects, valuations and management credentials and the reason behind the company’s decision to come out with a rights issue and so on.

DK Aggarwal is Chairman and MD, SMC Investments and Advisors.