A company life map - the rise and fall of a hot stock

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12. Scrip issue

One type of share issue that Country Bumpkin has not undertaken is the scrip issue, also known as a capitalisation issue or a bonus issue.

Bonus issue is a misleading term, because in no sense are shareholders getting anything for free, even though it may seem that way.

Scrip issues are born out of an accounting quirk. When a company has retained profits, these appear on its balance sheet as Profit and Loss Account Reserves. If the company has been trading profitably for some time, the reserves can far outweigh the Ordinary Share Capital of the company as a proportion of total Shareholders' Funds.

For instance, a company (not CB) might have Shareholders' Funds as follows:

Ordinary share capital (10p par value x 500 million shares in issue) = £50 million

Profit and Loss Account reserves = £250 million

Now suppose that this company has a share price of 900p which is quite heavy for a UK company. The directors of the company might decide that the shares would be more marketable if the share price was lower. One way to achieve this is to have a scrip issue, the basis of which is that part of the P&L Reserves are converted into new shares.

In the above example, the company might convert £50 million of Reserves into new shares.

It creates 500 million new shares at 10p par value
It uses £50 million from the Reserve account to make them "fully paid".
It distributes the new shares to existing shareholders pro rata to their existing holding
In this case, there were 500 million shares before the scrip and 500 million new shares have been created, so shareholders would get one new share for every share they already hold.

After the scrip issue shareholders funds would now look like this:

Ordinary share capital (10p par value x 1 billion shares in issue) = £100 million

Profit and Loss Account reserves = £200 million

Shareholders should not pop the champagne corks too quickly thought. True, they have twice as many shares as they had before. But total shareholders funds haven't changed. They are still £300 million. All that has happened is that £50 million has been moved from one row in the balance sheet to another.

And, of course, the price of the shares will be adjusted to reflect the fact that there are twice as many in issue. Instead of being 900p it will halve to 450p.

The other point to note is that if the company pays the same dividend per share after a scrip issue as it did the previous year, it will in fact be paying out a lot more. So dps will usually drop after a scrip.

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