When a company is doing really well, often they will split their stocks to try and continue this upward trend by making their stock price more attractive to the individual investor. However, often times, when a stock is in trouble, and looking to attract investors, they will do what is called a reverse split.
So, what is a reverse split? It is a proportionate decrease in the number of shares and price. However, not the value of shares of stock held by shareholders. In other words, the shareholders maintain the same percentage of equity as before the split. Let’s take a look at an example to clarify what a reverse split is:a 1-for-3 split would result in stockholders owning 1 share for every 3 shares owned before the split. A 1-for-3 split of someone with 90 shares at 100 dollars a share, after the reverse would have only 30 shares, but they would be at a price of 300 dollars a share. So, the number of shares goes down, but the price per share goes up, so the overall value (or equity) remains the same.
A company generally only institutes a reverse split when they are in need of a positive change. It is done to boost its stock’s market price and attract investors.
What it means:
Fewer shares, same overall price day of.
What to watch for:
As an investor it is important to understand the ins and outs of stock splits, especially those stock splits that are done in reverse. A reverse stock split will reduce the number of outstanding shares, and while occasionally this is done to simplify things, often a company will declare reverse splits to avoid being delisted.
What does it mean to be delisted, and why would that induce a reverse stock split? Being delisted can be devastating to a company, and thus to avoid it, and buy some time to get things spiraling upward instead of down, reverse stock splits occur. To really understand this, let’s look at some simple explanations:
In the stock market there are a few major stock exchanges, like the New York Stock Exchange. So, if a company can list their security with one of these exchanges, this is really good, as it is like publicity. Being listed with a major stock exchange means more liquidity for shareholders, which is huge. However, companies have to meet several criteria in order to be put on the list, and must maintain them to stay on the list. So, being delisted means they no longer meet the criteria and are taken off the list-a huge, sometimes fatal blow to a company.
These criteria vary some but usually include a minimum number of round lot holders (meaning shareholders owning more than 100 shares), minimum number of total shareholders, minimum net income, minimum public shares outstanding, and minimum price per share.
So, if you’re a company has a stock that has had some economic turmoil, the per share stock price may fall below the minimum. If the market prices continue to fall, the company risks being delisted from the exchange.
So, in order to avoid this, the Board of Directors may declare a reverse stock split. So, while the split has no real economic consequences, the price per share increases back above the minimum, and the company has now bought itself time. This does not always work, but it can be a good last ditch effort, especially when the decline is due to something that will end soon (perhaps it is a strike, or a lack of resources because of war that is causing the economic hardship). Often it gives the company just the right motivation to get things moving upward again, and the increased price can attract investors, even if it is just a psychological attraction as the value remains the same.
Another reason a company may declare a reverse stock split is to hide a declining stock price.
So, when you see a reverse stock split, really do your research before deciding to invest in that stock.