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What Is a Reverse Stock Split?

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  • Written By: Geri Terzo
  • Edited By: C. Wilborn
  • Last Modified Date: 25 August 2014
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A reverse stock split is a transaction in the financial markets that reduces the total number of shares outstanding in a stock, but lifts its per-share price. The way it works is if an investor holds 500 equity shares valued at $10,000 US Dollars (USD), for instance, and the company issues a reverse stock split, this changes the structure of the investor's holding to 250 shares but the holding is valued the same. Although the number of shares held decreases based on the split ratio, the value does not change. It does, however, increase the price barrier to entry for new investors.

Reverse stock split advantages are especially beneficial for the company issuing the transaction. This is true since the split does not impact the financial holding of an investor. A company might pursue a reverse stock split if management believes that investors are undervaluing the stock and that a depressed stock price is preventing new investors from buying in. Since a reverse split raises a stock's per share price by eliminating a percentage of outstanding shares, a result of the reverse split is that it appears demand in a stock went up, which could prompt momentum investors to purchase shares.

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Another benefit is keeping shares listed on a stock exchange. Major stock exchanges around the world are organized marketplaces and have standards for the companies that trade there. If a share price has been sold to below that standard and a company therefore faces having its shares delisted, a reverse stock split could prevent that from happening.

Reverse stock splits may also serve as a red flag to investors if there are substantial problems at a company and the reverse split is a last-ditch effort to turn things around. Investors should monitor a company's earnings growth and be wary of a company with excessive debt on its balance sheet. While many stocks have emerged more profitable from a reverse split, there are some companies whose problems are too big to disguise by inflating the stock price.

A consequence of a reverse stock split is that minority shareholders might lose a position in a stock altogether. If the value of a small investor's position is not enough to sustain a reverse split, the investor will receive cash for the shares. Although common shareholders are often entitled to a vote for many major company decisions, a board of directors may pursue a reverse stock split without shareholder approval, according to US regulation.

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LisaLou
Post 3

Are there online websites that have a list of recent stock splits? This sounds like something you would want to keep on eye on as a trader.

Either way you look at it, there could be trading potential from closely watching companies that split.

From the limited stock trading experience I have, I just remember learning that I must always do my own research. One thing that has stuck in my head is to never go into a trade that you have not researched yourself.

Understanding the company behind the stock is one of the first things to learn. If you blindly buy and sell stock based on what other people are telling you, your chances of success are pretty slim.

Mykol
Post 2

@andee - In my experience as an investor, I have not had very good luck when there is a reverse stock split.

I always kind of cringe when I see that this has happened. Even though the stock value is supposed to remain the same, it seems like trouble is brewing.

In many instances, it is only a matter of time before the company claims bankruptcy or dissolves. Not only is this frustrating from the standpoint of losing money, but is also a pain when it comes to doing your taxes.

There are always risks involved with trading stock. Now when I see that a company has done a reverse stock split, I usually sell my shares right away.

There have been too many times when I have held on for too long, and I have always been disappointed in the results.

andee
Post 1

I am new to trading stocks and learning all the terminology that goes along with it. So now I am wondering if a reverse stock split is good or bad?

I am somewhat familiar with how a stock split works, but am not real clear on the advantages or disadvantages of a reverse stock split. I don't see how only owning half as many shares could be a good thing.

It sounds like something that could be good for the company, but not so good for the stockholder.

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