Dividends, Bonus shares and
Buy Back- How they impact shareholders and a company?
- Rajeev Pathak
Introduction:
We often hear that the XYZ company has declared certain percentage
of dividend or a special dividend,
In the recent years, companies, particularly tech companies
are seen declaring Buy-Back of shares, and
Sometimes, we also read that the company has declared a bonus issue of shares.
In this article, we will discuss the impact on the wallet of a shareholder and on the financial of companies of dividends, special dividends, bonus shares and share buybacks.
Dividend:
The payment of dividends is the simplest way of distribution of profits of a company. This is nothing but a cash payout from the profits to its shareholders.
- It provides immediate income to the shareholders. Dividends are good for the investors, particularly retirees, seeking regular incomes.
- As the company is expected to maintain its dividend payment record for consecutive years, the dividends are distributed at such rate that the consistency could be maintained in the future. It also shows that the company is confident in having steady cash flows.
- The dividend income is taxable in the hands of shareholders.
- The payment of dividends reduces the companies' distributable profits and cash reserves.
Special Dividend:
· Definition:
A special is a one-time, extraordinary
dividend paid by a company, often at a higher rate than regular
dividends. It is not part of the normal payout policy.
· Reasons
for Special Dividend:
o
Windfall
profits (e.g., sale of an asset, subsidiary, or unexpected business gain).
o
Excess
cash reserves that management doesn’t need for operations.
o
Tax
efficiency (returning cash before a change in tax law).
· Impact
on Company:
o Significant
reduction in cash reserves and reserves.
o Signals
that the company has surplus cash but possibly fewer immediate investment
opportunities.
· Impact
on Shareholders:
o Immediate
one-time gain (extra cash received).
o After
the payout, the share price usually drops
by roughly the dividend amount because cash leaves the company.
o May
indicate the company is mature and has limited expansion prospects.
·
Regular
dividends make a company attractive for long-term investors, while special
dividends are like a bonus – good in the short term but may raise questions on the
company’s future growth plans.
When a company has sufficient reserves, it can issue free additional shares to existing shareholders by capitalising reserves. The company also has to visualise its future growth and profitability to make it confident about the serviceability of expanded equity.
·
Investor
benefit:
Increases number of shares held, but stock price generally adjusts downward in
proportion to the ratio declared.
·
Pros
:
o
No
cash outflow from the company.
o
Improves
liquidity of the stock as more free float is available in the market.
o
There
is no tax liability on receipt of bonus shares for the investors.
·
Cons:
o Does
not increase actual wealth immediately (like splitting a pizza into more
slices).
o If
fundamentals don’t improve, the stock may not rise in value.
Share Buy-back
·
Under buy-back a company
repurchases its own shares from investors, usually at a premium.
·
Investor
benefit:
Shareholders who tender shares get cash; others benefit from higher EPS
(Earnings Per Share) as total shares reduce.
·
Pros:
o
Tax-efficient
way of returning value (the buy-back tax is borne by the company).
o
Increases
per-share earnings and often boosts stock price.
o
Indicates
management confidence that the stock is undervalued.
·
Cons:
o One-time
event, not regular like dividends.
o If
done at too high a price, it may hurt long-term shareholders.
o Reduces the company's cash available for expansion.
Dividend vs. Buy-back vs.
Bonus Shares
|
Feature / Aspect |
Dividend |
Share Buyback |
Bonus Shares |
|
What it
is |
Cash
pay out from profits |
A company repurchases its own shares from investors |
Free
additional shares issued to existing shareholders |
|
Investor
Benefit |
Immediate
cash income |
Cash
(if shares tendered) + higher EPS for remaining holders |
More
shares held (wealth effect only if price rises later) |
|
Cash
Flow for Investor |
Yes,
direct cash |
Yes, if
participating in buy-back |
No
direct cash |
|
Impact
on Stock Price |
Usually
falls by dividend amount on ex-dividend date |
Often
rises (EPS increases, supply reduces) |
Price
adjusts downward in proportion to bonus ratio |
|
Tax Implication |
Taxed
as per investor’s income slab |
Buy-back
tax paid by company (cash received by investor is tax-free) |
No tax
on receipt of bonus shares (capital gains apply only on sale) |
|
Best
Suited For |
Income-seeking
investors (retirees, regular cash need) |
Long-term
wealth maximisers, if company is undervalued |
Growth
investors who prefer holding more shares |
|
Company’s
Cash Position |
Cash
outflow |
Cash
outflow |
No cash
outflow (just reserves capitalization) |
|
Message
to Market |
Stable
& consistent profit-making ability |
Management
thinks shares are undervalued, confidence in fundamentals |
Improving
liquidity, rewarding shareholders without cash payout |
|
Long-term
Effect |
Regular
income but no compounding |
Fewer
shares outstanding → higher EPS → possible higher valuation |
No
immediate wealth, but can boost value if earnings grow |
Which is Better for Investors?
·
For
Regular Income Seekers (retirees, conservative investors):
Dividends
are better, as they provide steady cash flow.
·
For
Long-Term Growth Investors:
Bonus Shares
are preferable, as they increase holdings without tax impact. Wealth grows if the company continues to perform.
·
For
Value/Wealth Maximisation:
Share buy-backs
often create higher long-term value by reducing outstanding shares and
improving EPS.
Conclusion:
·
Short-term
income = Dividend
·
Long-term
growth = Bonus Shares
·
Value
maximization / undervalued company = Buy-back
A well-managed company usually balances all
three over time.
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