The bonus hype

One thing that Nepalese investors are very enthusiast about is the bonus dividend. The regulators also seem to be fanatic about bonus in recent years. Every other market participant favour the same. In such a context, how can the board of directors of a company remain unaffected by the bonus mania when everyone around is crazy for it? Consequently, the BOD finds out ways to distribute matching bonuses as compared to the previous years. For that, they can do everything from normally writing back provisions to abnormally selling off the assets. Even the central bank mandates the bonus to be distributed by the financial institutions by capping the cash dividend.

Nowhere in the world, one can see such proactive regulators that hit hard on the autonomy of a company in decision making. The fundamental metrics of the company doesn’t matter as long as the company finds ways to distribute respectable bonus to its shareholders. Investors seem to be a bonus maniac. They don’t seem to care about the company, its business, and its reserves as much as the bonus. The majority of them regard bonus shares to be valuable. But, they do not realize that the bonus shares have no impact on their wealth and hence bonus shares itself has no value for them.

So, if everybody is absolutely loving the bonus shares, why do I even have a problem in the first place? Well, it’s because there seems to be inadequate understanding regarding the same. If we look at any other foreign country, people are not too enthusiast about the bonus as compared to us. It’s partially because they understand the long-term repercussions of the high bonus distribution. In Cash dividends, a company pays cash to its shareholders. However, the Cash dividend is considered unattractive in the Nepalese market and is given merely for tax adjustment purposes, except a few.

If we analyze the bonus dividend in accounting terms, what actually happens when the bonus is declared is that the amount in Reserve and Surplus is Capitalized. In a literal sense, the bonus is distributed to the shareholders. But, in reality, it’s just an adjustment game. For instance, if you have invested One lakhs in 100 shares of NABIL Bank, a bonus of 33 % means that you will have total 133 shares with an adjusted price of about 752. Theoretically, your total investment amount is still one lakhs only. Similar is the case with the company. The total market capitalization of the company doesn’t change due to the bonus dividend. So Effectively you have to wait for the price to be rise to realize the gain. In a bearish market, a 100% bonus also means loss since the prices fall even below the adjusted prices. Since the bonus is just an adjustment game, the capital remains with the company. But, it is plain illogical just to increase the capital. The Company could easily use the amount in reserve and surplus for any operational or expansion purposes.

If we keep a long-term view, we can see that the companies providing handsome bonus year on year has generally two disadvantages. The first one is that there is a risk of excessive capitalization in the case of large-cap companies. In an industry having limited business expansion scopes like banks, these companies cannot provide good returns with excessive capital. For Instance, GBIME Bank already has a capitalization of more than 23 Arab after a big merger with Janata Bank. Now, it is very difficult for the company to consistently provide good returns on the increased capital. This reduces the fundamental matrices like Return on Equity(ROE), Return on Capital Employed(ROCE), Earning per shares(EPS), etc.

This is because the company cannot provide good returns on a large capital base. The reduced matrices like ROE, ROCE, EPS, etc., will eventually be factored in and will be reflected in the price of the company. This impacts in lower capital gain as well as lower dividends in the coming years for the investors. So, the once-loved excessive bonus will eventually degrade the company’s performance in the long run, ultimately affecting the investors adversely. As a matter of fact, when a company continues to issue bonus shares rather than paying cash dividends, the cost of the bonus granted grows over time.

For Instance, let us consider NLIC. Suppose, an investor had entered the market just before the book close date at around 2872 levels 26 January 2021. The price adjusted for 31 % bonus was around the level of 2200. However, the market became bearish and the price of NLIC remained below 2200 levels. This simply means that the investors are still at loss despite a 31 % bonus. The 20 % cash dividend was the real cash that they received. Again, if we compare the dividend distributed by NLIC from FY 2068/69 i.e.; about 126 % (including 70 % bonus) to the latest dividend of FY 2076/77 i.e.; about 14 % bonus, we can see a clear picture of depleted dividend capacity.

The other risk is that the companies providing higher bonus are sure to deplete their reserves at a higher rate. If we see from a shareholder’s point of view, not all of them have an absolute craze for the bonus. They might be requiring the cash in hand for fulfilling other financial objectives. For Instance, many Investors plan to pay their yearly insurance premium and other expenses from the liquidity provided by the cash dividend. Investors may also be unwilling to dilute their stake in the company just for the sake of generating liquidity from bonuses by selling them. Also, since the price adjustment is done on the book close date, no extra wealth is created unconditionally. The condition is that the price of the bonus shares should rise after adjustment, which may not be possible in a bearish trend. A high bonus dividend for a few initial years will sharply reduce the rate of dividend in the future, which may be a headache to investors in a long run.

If seen from a company’s POV, bonus shares increase the number of shares that reduces the matrices like EPS, ROE, ROCE, Cash dividend yield, etc. due to which the company’s performance seems lower. The long procedure of intimating and obtaining approval from different regulatory authorities may cause the issuance of bonus shares to be delayed. In the Nepalese market, we can easily expect a time lag of more than two months for the bonus to be accumulated in the Demat account until which the bonus shares couldn’t be sold in the market. Investors perceive that the company should match the amount of bonus in the coming years, which will be a burdensome task for the companies. The issuance of bonus shares may also stimulate stock market speculation.

However, the bonus dividend has certain pros too. It is suitable for long-term investors who wish to create wealth. The company can retain its cash and use it for other expansion or operation purposes. Increasing the number of outstanding shares through a bonus issue encourages smaller investors to buy the company’s stock, so improving the stock’s liquidity. Normally, a bonus issue is an alternative way of distributing dividends to its shareholders but not the only way to distribute dividends. Investors perceiving the bonus as the only way to track a company’s performance is irrational. So, a rational investor of this era shouldn’t be a bonus maniac but instead, measure its cost-benefits and make wise investment strategies accordingly.