Why would a company want to do a reverse stock split?
Per-share price bumping is the primary reason why companies opt for reverse stock splits, and the associated ratios may range from 1-for-2 to as high as 1-for-100. Reverse stock splits do not impact a corporation's value, although they usually are a result of its stock having shed substantial value.
As per its definition, a reverse stock split increases the par value per share while its effect on the outstanding shares would be for it to decrease. Subsequently, this also increases the market price of the share which is the real reason why corporations result in a reverse stock split.
If you own 50 shares of a company valued at $10 per share, your investment is worth $500. In a 1-for-5 reverse stock split, you would instead own 10 shares (divide the number of your shares by five) and the share price would increase to $50 per share (multiply the share price by five).
Reverse splits also can diminish or force out small investors, who may not have enough shares to be consolidated. 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.
A reverse stock split tends to occur with small companies that believe their stock price is too low to attract investors.
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 Splits Aren't All Bad
Sometimes companies decide to reverse split their shares just because they want to offer their shares at reasonable prices to attract new shareholders. There are examples of stocks that have prospered after doing so, including Citigroup (C).
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 stock split is when a company breaks up its existing shares to create a higher number of lower-value shares. Stock splits reduce the trading price of a stock, which makes it more liquid and more affordable for investors.
After all, no one likes buying into a company whose share price looks too low to be real. That being said, there are also risks associated with investing in companies that have recently undergone reverse splits. These include reduced liquidity and increased volatility due to fewer available shares on the market.
Can a reverse split be bullish?
An Important Cue from Financial Execs
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.
While a standard forward stock split is generally considered bullish, a reverse stock split is typically considered bearish.
For example, if you had an option for 7,000 shares at an exercise price of $5.00 before the reverse split, then after the reverse split, you will have an option for 1,000 shares at an exercise price of $35.00. All other terms and conditions of the Offer remain the same.
Disadvantages of a Stock Split
The company wanting to split their stock must pay a great deal to have no movement in its over market capitalization value. A stock split isn't worthless, but it doesn't impact the fundamental position of a company and therefore doesn't create additional value.
- Broadcom (AVGO) Source: Sasima / Shutterstock.com. Broadcom (NASDAQ:AVGO) is the most expensive stock on this list on a per-share basis. ...
- Deckers Outdoor (DECK) Source: BalkansCat / Shutterstock. ...
- Nvidia (NVDA) Source: Poetra.RH / Shutterstock.com.
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.
A stock split typically does not have a direct impact on preferred stockholders. Preferred stock represents ownership in a company, but it usually comes with fixed dividend payments, which are not affected by it.
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.
As a result of the reverse stock split, every thirty pre-split shares of common stock outstanding will become one share of common stock.
What is a reverse stock market crash?
Reverse market crashes often result in an increased wealth gap, where the rich get richer, and the poor become relatively poorer. In other words, the sudden surge typically benefits those already invested in the market, leaving others behind.
A reverse split reduces the overall number of shares a shareholder owns, causing some shareholders who hold less than the minimum required by the split to be cashed out. The forward stock split increases the overall number of shares a shareholder owns.
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.
A stock split lowers its stock price but doesn't weaken its value to current shareholders. It increases the number of shares and might entice would-be buyers to make a purchase. The total value of the stock shares remains unchanged because you still own the same value of shares, even if the number of shares increases.
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.
