In equity markets, companies often take corporate actions to make their shares more accessible and liquid without altering the underlying value of the business. Two such commonly misunderstood actions are stock splits and bonus shares. While both result in an increase in the number of shares held by investors and a reduction in share price, the mechanics, accounting treatment, and tax implications, especially in a country like Pakistan, are materially different.
This article explains how stock splits and bonus shares work, why companies issue them, how they are computed, and how investors should interpret their impact.
What Is a Stock Split?
A stock split occurs when a company divides each existing share into multiple shares in a fixed ratio, such as 2-for-1 or 5-for-1. The key point to note is that a stock split does not change the company’s market capitalization or the investor’s total investment value.
How a Stock Split Is Computed:
Assume an investor owns 100 shares priced at PKR 1,000 each:
- Total value before split = 100 × 1,000 = PKR 100,000
If the company announces a 5-for-1 stock split:
- Number of shares after split = 100 × 5 = 500 shares
- New price per share = 1,000 ÷ 5 = PKR 200
- Total value after split = 500 × 200 = PKR 100,000
Although the share price declines after a stock split, this reduction is purely mathematical and does not represent any loss in the investor’s wealth. The company’s market capitalization remains unchanged because the decrease in price is exactly offset by an increase in the number of shares outstanding. In other words, both the company’s economic value and the shareholder’s proportional ownership remain the same before and after the split.
This adjustment becomes effective from the ex-date, which is the date on which the stock begins trading without the entitlement to the pre-split share structure. On the ex-date, the exchange automatically recalibrates the share price to reflect the new split ratio. As a result, when the market opens on the ex-date, the stock is quoted at the adjusted lower price, and investors already holding the stock see their increased number of shares reflected in their accounts.
Why Companies Issue Stock Splits?
Companies typically issue stock splits to:
- Reduce the per-share price and improve affordability
- Increase the number of shares available in the market
- Enhance liquidity, making trading easier for investors
In Pakistan’s trading context, United Bank Limited (UBL) serves as a useful example for understanding stock splits. The financial institution announced a 2-for-1 stock split, doubling its outstanding shares while proportionately reducing the share price. Prior to announcing its 2-for-1 stock split, UBL had approximately 1.2 billion shares outstanding in the market. Under a 2-for-1 split, every existing share was divided into two identical shares. As a result, the total number of shares outstanding nearly doubled, increasing from around 1.2 billion to approximately 2.5 billion shares after the split.
What Are Bonus Shares?
Bonus shares are additional shares issued to existing shareholders free of cost, based on a specific percentage (e.g., 20%, 50%, or even 800%). Unlike stock splits, bonus shares are issued out of a company’s reserves, such as retained earnings.
How Bonus Shares Are Computed:
Suppose an investor holds 1,000 shares priced at PKR 120 each:
- Total value before bonus = 1,000 × 120 = PKR 120,000
If the company announces a 20% bonus issue:
- Bonus shares received = 20% of 1,000 = 200 shares
- Total shares after bonus = 1,200 shares
To adjust the price:
- Adjusted price = 120 ÷ (1 + 0.20) = PKR 100
- Total value after bonus = 1,200 × 100 = PKR 120,000
Once again, the investor’s total value remains unchanged. The price adjustment occurs on the ex-date, and the bonus shares become visible in the investor’s account shortly afterward.
Why Companies Issue Bonus Shares?
Companies issue bonus shares to:
- Improve share liquidity
- Lower the trading price, increasing market participation
- Signal confidence in long-term growth
In recent times, Mari Energies (formerly Mari Petroleum) has emerged as an example of a company issuing bonus shares in Pakistan’s stock market. In 2014, the energy company issued an 800% bonus issue, i.e., eight bonus shares for every one share held to its shareholders. This effectively increased shares ninefold (original shares plus 800% bonus), reducing the share price from around PKR 3,600 to approximately PKR 400. Following the bonus issue, the company experienced a noticeable increase in trading activity, as the volume of trade had risen. The company also experienced an improvement in liquidity.
Key Difference: Tax Treatment in Pakistan
One of the most important differences between bonus shares and stock splits for Pakistani investors lies in taxation.
Stock Splits:
In Pakistan, no tax is applied to stock splits because there is no concept of “additional income.” Shares are merely subdivided.
Bonus Shares:
Bonus shares are treated by the government as additional income, even though the investor’s overall value does not increase. As a result, a withholding tax (currently 15%) is applied.
Suppose you originally own 100 shares priced at PKR 520 each. The total value is:
100 × 520 = PKR 52,000
After a stock split, the number of shares doubles to 200, while the price per share halves to PKR 260. The total value remains unchanged:
200 × 260 = PKR 52,000
No tax is applied, so you retain the full value of your investment. However, with bonus shares, the government applies a 15% tax on the additional shares. This means that instead of receiving 100 extra shares, you effectively receive 85 additional shares. Assuming the stock price adjusts to PKR 260, the total value becomes:
260 × 185 = PKR 48,100
This tax liability reduces the attractiveness of bonus shares compared to stock splits. As a result, stock splits have become more common in Pakistan, while the issuance of bonus shares has declined. For instance, Mari Energies and Fast Cables were likely the last company to issue bonus shares, whereas companies like Lucky Cement (5-for-1), Systems Limited (5-for-1), Arif Habib Corporation (10-for-1), and UBL (2-for-1) have recently issued stock splits.
Bonus Shares vs. Stock Splits: Final Perspective
While bonus shares and stock splits may appear similar on the surface, they differ in source, accounting treatment, and taxation. Stock splits are simpler, tax-neutral, and purely structural, whereas bonus shares involve reserves and attract tax in Pakistan.
As an investor, understanding these distinctions can be useful for making better-informed decisions regarding your investments. If you are looking for a platform to start trading, download Finqalab now. Our platform takes care of ex-dates and post-adjustment prices, so you can focus on trading only.