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Thursday, October 8, 2009

1:1 Bonus announcement by Reliance Industries - is it good news for investors?

Reliance Industries made the bonus announcement after the Indian stock markets closed for trading on Oct 7 '09. Today (Oct 8 '09), the stock closed up by less than 1% at 2120 - still more than 15% below its high of 2490 on May 19 '09.

A 1:1 bonus - particularly when announced after 12 years in the midst of a strong bull rally - should have elicited joy and buying euphoria among market participants. Why? Because bonus shares are considered to be beneficial to shareholders. From Reliance, the 'gift' should have appeared an extra special one.

In reality, it should make no difference to a shareholder's wealth. No doubt bonus issues offer 'free' shares on which dividends are paid in the future. But the share price is adjusted downwards depending on the bonus ratio. In the case of a 1:1 bonus, 100 shares will become 200 shares, but the share price prevailing on the record date will get halved after the bonus issue.

A shareholder's wealth remains the same - double the shares at half the price. What can happen after the bonus issue? One year later, dividends are likely to be paid on the enhanced quantity of shares, but the dividend payout ratio is usually maintained by reducing the dividend percentage. The total dividend received by the shareholder remains the same.

There is a downside as well. After receiving the bonus shares, many shareholders sell the original quantity - specially if bought less than a year back - to book a short-term loss and get a tax break by adjusting the loss against short-term profits. This selling pressure pushes the stock price below the already halved ex-bonus price. So the actual wealth of shareholders, who do not avail the tax break, may go down after the bonus shares are issued.

But there are long term benefits if the company continues to perform well in the future - and Reliance should do so. (A bonus announcement is management's way of communicating a bright future to shareholders.) The dividend payments gradually increase, and the investor receives a higher amount each subsequent year.

Why the muted buying? Several reasons. The company's performance over the next few quarters are not likely to be exciting. The KG basin gas selling fiasco and the ongoing public feud amongst the Ambani siblings is creating negative ripples in Government circles, and uncertainty among large shareholders.

Reliance had out-performed the Sensex by gaining 167% from its Oct 27 '08 low of 930 to its May 19 high of 2490. Subsequently, the stock has under-performed by going through a 4 months long sideways consolidation.

If 'good news' doesn't move a stock up sufficiently, it is an indication that there is no longer enough buying interest in the stock. The fact that the Sensex is in some sort of a topping formation is also restricting the bulls at the Reliance counter.

Existing investors may continue to hold. New entrants can make a token purchase at current price, and buy more on dips. (I stay far away from any stock with the 'Reliance' name in it.)

Related post

Why rely on Reliance?

3 comments:

Titu said...

Hello Sir,

I too follow the same thing which you have written in last line within bracket

ambardekarsuchita@gmail.com said...

Hi,
Well written piece and good argument....all over the place and many sites and blogs this news was flashed....

But your blog content was diffrent....In any of this information.available on net nobody carried the information on last date where in the purchase can avail the investor bonus share...or the rich dividend declared...if you could carry the dates...then investor like me would be very much interested...

Subhankar said...

@Titu: Don't get too influenced by my biases. A lot of investors have made a ton of money investing in Reliance group shares!

@suchita: Appreciate your comments.

Check the BSE and NSE sites regularly for announcement regarding record dates for the dividend and bonus.