 "Understanding the rationale behind ex-bonus shares")
Retail brokers have a difficult time explaining the concept of ex-bonus to their investors. Tech Mahindra and HCL Technologies are trading at their ex-bonus prices and sharply lower than what they were trading the previous day. Tech Mahindra was trading at Rs 2,800 on Wednesday, March 18, while on Thursday it is trading at Rs 690.50. Similarly HCL Tech is trading at Rs 990 as compared to a price of Rs 2007.80 the previous day.
The problem of understanding the concept is specially faced by people who have inherited the shares and have little idea about investing in shares. There are also those who ask their brokers or advisers whether it is a good time to buy now since the price has ‘crashed’.
Let’s try to understand the concept of ex-bonus first. A share becomes ex-bonus when the purchaser does not have the right to receive the current bonus. Bonus shares are free shares that a company announces for its shareholders. Thus when the share is trading at an ex-bonus price like HCL Technologies and Tech Mahindra are trading today, those investors who will buy the shares today will not get the bonus shares announced by the company. The difference in price is mainly on account of losing out the right of availing the bonus.
HCL Tech, announced a 1:1 bonus, which means it gave away one share free for every share held. This offer closed on Wednesday March 18, 2015. Share price on Wednesday was Rs 2007.80 while today it is Rs 990, a loss of Rs 1017.80. The difference is mainly because the investor who buys HCL Tech today does not get the right to the free shares of around Rs 1,000.
Since existing shareholders do not see the bonus shares being credited to their demat account immediately after the price of shares have turned ex-bonus, there is generally a panic. It takes a maximum of two-three days for the shares to appear in your demat account. After the shares are credited the value of shares that are held by the investors comes back to the original level.
Generally whenever a company announces a bonus issue its share price rises as investors jumps in to get a hold of a piece of the free shares. Theoretically, however, bonus shares are not good for the share price as it increases the liquidity and supply in the market. Many big companies have never announced a bonus share despite strong fundamentals. Take the example of Berkshire Hathway owned by legendary investor Warren Buffet. Berkshire Hathway trades at $219,699 or Rs 1.30 crore per share and has never announced bonus shares; in fact, the company has announced share buybacks.
However, companies in general like to use bonus issues as a statement of their strong fundamentals going forward. It reflects their capability of servicing their increased capital. Companies also use bonus shares to improve participation and liquidity in their company, something that Buffet does not believe in.
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When a share turns ex-bonus, it tends to stay subdued for some time. This is because investors do not expect any positive surprise in terms of price action from the promoters. But if the rationale behind issue of bonus shares is that the company is expected to do better in the future, it is better to buy in such companies.
Tech Mahindra has recently said that they want to be a design house for the aerospace sector, one of the few sectors that is doing very well globally despite an overall slump in world economies. The company is also increasing its focus on defense sector and is working closely with Defense Research and Development Organisation. Announcing the bonus issue reflects the confidence of the management for growth in the future.
HSBC Global Research in a report on the IT sector says it prefers HCL Tech because of its predictable and low risk business model. The company has restructured its operations and announced global tie-ups recently. It is probably these steps and a clearer visibility of scaling its business that has prompted the company to announce a bonus issue.