A reverse stock split is a reduction in the number of companies traded shares that results in an increase in the value of the shares but a decrease in how many shares are available to purchase. for example, a 2:1 reverse stock split, a company would take every two shares and they would be replaced with one share this is also called a merge between two shares. The reason companies chose to do this is because their stock price has gotten too low, so the reverse split increases the price per share.
Why Would A Company Reverse-Split Its Shares
A company may declare a reverse stock split in an effort to increase the trading price when a company 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. In some reverse stock splits, small shareholders are “cashed out” (receiving a proportionate amount of cash in lieu of partial shares) so that they no longer own the company’s shares. Investors may lose money as a result of fluctuations in trading prices following reverse stock splits. The shares may get an initial boost, don’t expect it to last. If a company’s fortunes—and shares—have been decreasing, smart investors will see the reverse split as a big red flag and continue selling, sending the share price back down Although it could improve share price for the short term, the market cap does not change.
Most but not all reverse stock splits are seen in penny stocks because these companies have not been able to attain steady profits or fail to create any value for shareholders. The most recent stock splits in the Marijuana sector had made me realize that these companies were very attractive towards novice investors but had failed to be profitable what so ever so many of these companies did reverse stock splits and the uneducated investors got killed.
Sometimes companies will affect a reverse stock split so that their shares trade higher and it attracts investors to join the pump and dump bandwagon. A company that recently did this was liberty travel their stock soared to 130% because of the stock split many novice investors jumped on the train until the next day came and the stock gapped down -27%. These companies do this with the intention of making their companies more attractive to mainstream investors and/or to ease the way to listing on a national exchange.
The picture below shows what happen to Liberty TripAdvisor.
Aurora Cannabis did a 12:1 reverse split in April because their stock had to go delisted because it went below $1.00. “The Company expects the Consolidation to restore compliance with the NYSE’s continued listing standards, and to continue to provide access to a broad universe of investors, access to equity capital and trading liquidity.” Auroras stock fell from $10 to 74 cents in just a year so a reverse split makes
Evaluating Share prices
The total value of all the companies shares stays the same before and after the reverse split. Say a company has 5 million outstanding shares and a stock price of 50 cents a share, for a market cap of $2.5 million. It then executes a 1-for-4 reverse split, reducing the number of shares to 1.25 million.
The company’s value remains the same, at $2.5 million, so now each share is worth $1. If you owned 100 shares at 50 cents apiece before, now you own 25 shares worth $1 apiece. The total value of your investment remains the same: $50. Nothing about the company has changed except the number of shares available.
Marc Gerstein, director of investment research at Multex, advises investors to stay away from reverse stock splits, he stated “If I had a company that announced a reverse split, I’d sell it,” he said. “I’d rather see them improve operations” to boost the stock. Another expert investor Charles Kaplan, President of the investment consulting firm equity analytics stated “It is usually a very negative sign when a company reverse splits their stocks.” But how the market reacts often depends on what else the company is doing to reverse its fortunes”. That being said As a young investor i would avoid reverse splits at all costs. The danger in stock splits is when people think they are buying a $10 stock after a split that was originally worth $.50 a stock. The risks are much higher than most investors perceive. Stock splits are nothing more than smoke and mirrors. They don’t create any real value. If you own a stock and it does a stock split or reverse stock split, it might be time to look for a different investment.