1. Dividends
During a bull market capital gains take precedence over dividends. This is because a dividend is always on face value and not on market value. Consequently, even if a company whose share price is say ruling at Rs. 400 declares a healthy dividend of say 60% (face value Rs. 10), the dividend while being at Rs. 6 per share, the dividend yield would be an abysmal 1.5%. However, it doesn't mean that dividends are of no significance to shareholders. Apart from the utility during a bear phase, dividends are looked upon by the market at large as an important signaling mechanism determining the health of the corporate. Dividends are paid out of reserves and by paying dividend the company is distributing a part of its reserves amongst shareholders. However, there is another school of thought that considers dividend payouts as a waste of money. Fast growing companies are perceived to be much better off ploughing their profits back. Case in point : Most of the US tech giants are extremely stingy dividend payers. Equity dividends in India are tax-free in the hands of share holders. However, u/s 115O, the company distributing the dividend has to pay a dividend distribution tax of 12.8125% to the exchequer. In effect, it is the share holders who bears the tax since they receive that much lesser amount as dividend. Also, the dividend amount gets subjected to tax twice, once at the company's end since it is the post tax profits which may be distributed as dividend and the second time as dividend distribution tax. Hence sometimes reserves may even be distributed as bonus shares.
2. Bonus shares
Bonus shares are nothing but shares issued free of cost to the shareholders of a company, by capitalizing a part of the company's reserves. Following a bonus issue, though the number of total shares increase, the proportional ownership of shareholders does not change.
Also, post the bonus the cum bonus share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the share holder. However, more often than not, as explained earlier, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.
As far as tax is concerned, since no money is paid to acquire bonus shares, these have to be valued at nil cost while making calculations for capital gains. An incidental benefit is that since the price more or less falls in proportion to the bonus, there may arise an opportunity to book loss on the original shares.
3. Stock splits
Stock splits are a relatively new phenomenon in the Indian context. It is important that investors understand the reasons that companies may split their shares and how a stock split is different from a bonus issue. A stock split is when the number of shares in a stock is increased and the value per share is decreased. This in no way affects the intrinsic value of your investment and has no effect on your net wealth. A typical example is a 2-for-1 stock split. Say a company announces a 2-for-1 stock split in one month. That means one month from that date, the company's shares will start trading at half the price from the previous day. Consequently you will own twice the number of shares that you originally owned and the company in turn will have twice the number of shares outstanding. The question that arises is if there is no difference to the wealth of the investor, then why does a company announce a stock split. Well, the primary reason is to infuse additional liquidity into the shares by making them more affordable. Here it has to be reiterated that the shares only appear to be cheaper, it makes no difference whether you buy one share for Rs.3,000 or two for Rs.1,500 each. As far as the tax implications for stock splits are concerned, well, there aren't any. A stock split, like a bonus issue, is tax neutral. However, when the shares are sold, the capital gains tax implications are different that what is applicable for bonus issues. Here, the original cost of the shares also has to be reduced.
During a bull market capital gains take precedence over dividends. This is because a dividend is always on face value and not on market value. Consequently, even if a company whose share price is say ruling at Rs. 400 declares a healthy dividend of say 60% (face value Rs. 10), the dividend while being at Rs. 6 per share, the dividend yield would be an abysmal 1.5%. However, it doesn't mean that dividends are of no significance to shareholders. Apart from the utility during a bear phase, dividends are looked upon by the market at large as an important signaling mechanism determining the health of the corporate. Dividends are paid out of reserves and by paying dividend the company is distributing a part of its reserves amongst shareholders. However, there is another school of thought that considers dividend payouts as a waste of money. Fast growing companies are perceived to be much better off ploughing their profits back. Case in point : Most of the US tech giants are extremely stingy dividend payers. Equity dividends in India are tax-free in the hands of share holders. However, u/s 115O, the company distributing the dividend has to pay a dividend distribution tax of 12.8125% to the exchequer. In effect, it is the share holders who bears the tax since they receive that much lesser amount as dividend. Also, the dividend amount gets subjected to tax twice, once at the company's end since it is the post tax profits which may be distributed as dividend and the second time as dividend distribution tax. Hence sometimes reserves may even be distributed as bonus shares.
2. Bonus shares
Bonus shares are nothing but shares issued free of cost to the shareholders of a company, by capitalizing a part of the company's reserves. Following a bonus issue, though the number of total shares increase, the proportional ownership of shareholders does not change.
Also, post the bonus the cum bonus share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the share holder. However, more often than not, as explained earlier, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.
As far as tax is concerned, since no money is paid to acquire bonus shares, these have to be valued at nil cost while making calculations for capital gains. An incidental benefit is that since the price more or less falls in proportion to the bonus, there may arise an opportunity to book loss on the original shares.
3. Stock splits
Stock splits are a relatively new phenomenon in the Indian context. It is important that investors understand the reasons that companies may split their shares and how a stock split is different from a bonus issue. A stock split is when the number of shares in a stock is increased and the value per share is decreased. This in no way affects the intrinsic value of your investment and has no effect on your net wealth. A typical example is a 2-for-1 stock split. Say a company announces a 2-for-1 stock split in one month. That means one month from that date, the company's shares will start trading at half the price from the previous day. Consequently you will own twice the number of shares that you originally owned and the company in turn will have twice the number of shares outstanding. The question that arises is if there is no difference to the wealth of the investor, then why does a company announce a stock split. Well, the primary reason is to infuse additional liquidity into the shares by making them more affordable. Here it has to be reiterated that the shares only appear to be cheaper, it makes no difference whether you buy one share for Rs.3,000 or two for Rs.1,500 each. As far as the tax implications for stock splits are concerned, well, there aren't any. A stock split, like a bonus issue, is tax neutral. However, when the shares are sold, the capital gains tax implications are different that what is applicable for bonus issues. Here, the original cost of the shares also has to be reduced.
4. Share buybacks
Even share buybacks are a comparatively new phenomenon. Reliance and Siemens are a couple of examples of companies which have bought back their shares. A buyback is essentially a financial tool in the hands of the corporate that affords flexibility in the capital structure. A buyback in this case allows the company to sustain a higher debt-equity ratio. It is also a tool to defend against possible takeovers. Generally companies buyback when they perceive their own shares to be undervalued or when they have surplus cash for which there is no ready capital investment need. Stock buybacks also prevent dilution of earnings. In other words, a buyback program enhances the earnings per share, or conversely, it can prevent an EPS dilution that may be caused by exercises of stock option grants etc.
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