Who benefits from a reverse stock split?
Attract big investors: Companies also maintain higher share prices through reverse stock splits because many institutional investors and mutual funds have policies against taking positions in a stock whose price is below a minimum value.
A reverse stock split has no immediate effect on the company's value, as its market capitalization remains the same after it's executed. However, it often leads to a drop in the stock's market price as investors see it as a sign of financial weakness.
One way is to buy shares of the company before the reverse split occurs with the plan to sell them soon afterwards. This can be profitable if the company's stock price increases after the split. Another way to make money from a reverse stock split is to short sell the stock of the company.
Reverse stock splits work the same way as regular stock splits but in reverse. A reverse split takes multiple shares from investors and replaces them with fewer shares. The new share price is proportionally higher, leaving the total market value of the company unchanged.
Reverse Splits Aren't All Bad
There are examples of stocks that have prospered after doing so, including Citigroup (C). Citi probably had the most famous reverse split—a 1 for 10 reverse split in May 2011. Citi became a $40 stock and is now trading at $55.
Selling before a reverse stock split is a good idea, but selling after the reverse stock split is not. Since you can sell before and after a reverse stock split, selling during one is optional. The main advantage of selling before the reverse stock split is that you don't have to wait around for it to happen.
A company may declare a reverse stock split in an effort to increase the trading price of its shares – for example, when it believes the trading price is too low to attract investors to purchase shares, or in an attempt to regain compliance with minimum bid price requirements of an exchange on which its shares trade.
This type of stock split is often done to increase share prices. While a reverse stock split can improve a stock's price in the near term, it could be a sign that a company is struggling financially. Large fluctuations in stock pricing associated with a reverse stock split could also cause investors to lose money.
In a reverse stock split, a company consolidates its shares at a specific ratio, reducing the total number of shares and increasing the price per share so the total dollar value of each stockholder's investment remains the same but the stock price increases.
Priceline.com (BKNG 0.06%) is the biggest winner. It went through a 1-for-6 reverse split in 2003 when the online travel portal was flopping around after the dot-com bubble burst. Priceline has since become an 85-bagger -- not a bad haul over the past 14 years.
Why do investors hate reverse splits?
Many times reverse splits are viewed negatively, as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted. The higher-priced shares following the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices.
The reverse stock split doesn't cause investors to lose money by itself, but the move can signal to investors that the company is in financial trouble, which can lead to a sell-off. This will lower the value of the stock price, and stockholders will lose money.
It tells the investing public that the company is confident that their stock will rise back to the pre-split level and is generally seen as a bullish signal by investors who in turn tend to take the stock higher.
Regular and reverse stock splits do not change the value of one's position, only the number or shares outstanding. They do not trigger short squeezes. To the extent that they might, I would suggest that reverse-splits are a way for a very weak stock to push its price up so that the stock doesn't get delisted.
Some companies may only conduct a reverse split once, while others may do it multiple times. Reverse splits are more common among small-cap stocks than large-cap stocks.
For example, if most shareholders of a stock own fewer than 1,000 shares, the company can do a 1:1,000 reverse split and squeeze out the investors who own fewer shares by paying them for their holdings. Those shareholders would either have to accept that price or buy more shares to total 1,000.
Reverse Splits
Reverse stock splits are less common among seasoned companies that trade on one of the major U.S. stock exchanges. If a reverse split is announced and actually occurs, proceed with caution. Reverse splits tend to go hand in hand with low-priced, high-risk stocks.
The cost basis per share remains the same. The split and reverse split have no impact on the cost basis per share. The new cost basis per share of ABC is $75.25. The new cost basis per share of XYZ is $12.00.
A reverse stock split may be used to reduce the number of shareholders. If a company completes a reverse split in which 1 new share is issued for every 100 old shares, any investor holding fewer than 100 shares would simply receive a cash payment.
Stock splits are generally not taxable, as the cost basis per share is updated to reflect the new stock structure and price so that the total market value is the same.
What is a 1 for 20 reverse split?
At the effective time of the reverse stock split, every twenty (20) issued and outstanding shares of the Company's common stock will be automatically converted into one (1) share of the Company's common stock without any change in the par value per share.
For example, if a company decided on a 1-for-50 reverse split, any holders of fewer than 50 shares wouldn't be offered a fractional new share. They would instead be paid cash for their shares.
From time to time, stock splits are followed by a bump in stock performance—but not always. Is the split worth it? – Stock splits have no tangible impact on a company's total value—they simply create more shares at more affordable prices.
On the other side of the spectrum, a company may decide to issue a reverse split to minimize the outstanding shares, float and liquidity. This action basically merges existing shares.
Don't buy just because of the split
Nothing will change about the company's underlying prospects when it increases the number of outstanding shares. Yes, stock splits can sometimes cause a stock to jump.
