Reverse stock splits, so what are they?
It’s the exact opposite of a regular stock split. Under a normal 2 for 1 stock split, the investor would receive 2 shares for each share they hold, and the price is cut in half. Now with a reverse stock split, the investor can receive 1 share for each 2 shares held, and the price is doubled. Like a regular stock split, this has no effect on the value of the investor’s holdings.
So, why is this being done by some companies? Many major stock market exchanges have minimum requirements for stock price levels. These reverse splits are typically done to keep the stock price above this minimum so they do not get booted off the exchange. If a stock does fall below this minimum, the exchange can remove the company off the exchange. A quick fix to this is to perform a reverse stock split.
Investors need to be aware of these reverse stock splits because they have to realize that the stock did not double due to any strength in the business. Rather, it’s just a bookkeeping change that doesn’t tell you anything about the health of the business. In fact, as many as 75% of all stocks dip even lower after a reverse stock split.
The bottom line is that most reverse splits can mean trouble to the company itself because they’re simply cosmetic changes that do nothing to reverse ugly trends at a company. It’s mainly a last resort strategy for companies.
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