Most investors would like to see their stock
split, since the thought of acquiring more shares seems like a better
outcome to boost potential growth.
A reverse stock split, however, is when a company lessens the overall amount of its outstanding shares. This simply means the company does this to raise share price and shareholders will have fewer shares.
What exactly is a reverse stock split?
Also termed as stock consolidation or share rollback,
reverse stock split is a corporate action that reduces a company’s outstanding
shares, and at the same time raises the price per share.
A reverse split takes various shares from investors and trades
them with a smaller amount of shares in return.
This result to a higher new share price, which makes no changes
to the value of the investor’s position in a stock nor does it affects the
accounting equation. Still, some
investors can cash out their positions if they have a small amount of shares.
How it works
1-for-2 Reverse Split
In a 1-for-2 reverse split, an investor will have 1 share
for every 2 that he previously owned. If he has 1,200 shares, then he would end
up with 600 shares.
Another example would be if he had 20 shares at $10 before
the reverse, then he will own 10 shares worth $20, but the investment’s value still
remains at $200.
1-for-3 Reverse Split
The investor will have 1 share for every 3 that he owns,
therefore providing him with 400 shares after the reverse split, given that he
has 1,200 shares before the split.
Is it good or bad?
Reverse stock split are usually deemed as a worrying move.
It is often performed by companies that experienced their stock prices dropped
in the $1 level. A business standing at this level is at risk of being potentially
delisted from stock exchanges.
This move is vital to ensure a common stock or preferred stock maintains its listing
requirements on the market.
Given that reverse stock split has so far made no negative
economic impact, hypothetically, this action is neither good nor bad for
companies and stockholders in and of itself.
It is more important to monitor the financial condition of a
stock to determine whether a reverse split could work in the long run.
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