Are Reverse Stock Split Good or Bad? Definition & How to Profit

Trading concepts

Are Reverse Stock Split Good or Bad?

Are you thinking that is reverse stock split good or bad? What is a reverse stock? We are here to help you out. If you will have two bills of $50 and one bill of $100. You might answer that it doesn’t matter if you understand the immediate impact of reverse stock splits.

What is the meaning of reverse stock split?

Before we discuss whether the reverse stock split is good or bad, we will tell you about the reverse stock split. The Reverse stock splits happen in the company does trading at the public level. It happens when the company divides shares.

These shares are of investors that are holding a specific amount that will cause the stock price of the company to increase accordingly. This increase isn’t driven by any positive results or changes to the company.

When there is a reverse stock split, the market capitalization of the company does not change. Moreover, the value of shares also does not change. The thing that changes is the number of shares that the company owns.

For example, if the company is having 50 shares that are having a value of $10 for each one. The investment will be $500. When we talk about the reverse stock split, then the company will only own 10 shares. Here, the share price will increase to $50. It is opposite to the stock split.

Why do companies perform reverse stock splits?

There are many reasons behind the Reverse Stock Split. The major reason to do a reverse stock split is to stay listed in the major exchanges by engaging.

But there are many other reasons also. If the share price of any company is too low, then it is possible that investors will steer clear of the stock out of fear. There can be the perception that low price reflects unproven or a struggling company. For overcoming this, the company uses a reverse stock split.

No matter what, the reverse stock splits are red flags to investors. But it is not the same in all cases. You can get two outcomes out of Reverse Stock Split. Below are these:

Positive Impact

The companies that are using reverse stock splits are always in distress. But if there is a company that times the reverse stock splits. It times it along with many significant changes like improving operation, earning through projects and many other important factors for investors, the price will be high.

In the above example, reverse stock splits are best for both companies as well as the investors.

Negative Impact

If there is a company that does not successfully add improvements into its operations along with initiating a reverse stock split. The price of the stock will continue to slide. It will sparkle even more concern over the fate of the company.

Is reverse stock splits a signal to sell?

If there is a company that announces the Reverse Stock Split, you might be thinking about how to react. The stock splits are the first sign that the company is thriving. The struggling firms use the reverse stock splits and are the major red flag.

As you may see, the Reverse stock splits boost the share prices of a company. The high share prices are good. But the increase that comes from a reverse split is basically an accounting trick. You must know that the company is not that much of a value as it was before the reverse split.

Here is a tip for you! Although the reverse split can help in improving the share price. It is really important to remember that the company’s market capitalization has not changed at all. If you will keep that thing in mind, then you will consider the reverse split nothing more than a distraction for investors during times of uncertainty.

The Mechanics of a Reverse Split

The companies cancel all of their outstanding stocks in the reverse split. Then they distribute the new shares to the stockholders. The new share gain is directly proportional to the shares that companies own before.

For example, if you are owning 1200 shares, then you will wind up with 600 shares. But if there is one for three splits, then you will have one share only. Then here, you will emerge from the reverse split, having 400 shares.

Minority Stockholders and Reverse Stock Split

The minority stockholders can use a reverse split. By this, they can extinguish the position, and you force out. But here is bad luck. You cannot do much over here as long as the reverse split is following legal procedures.

The chance to prevail in a lawsuit that is against the board of directors will be very low. If there is any conflict, fraud, or anything else, the corporation can take charge of minority stakeholders.

Advantages of Reverse Split

The Reverse Stock Split can be good news or bad news for the investors. In a reverse split, the investors will know whether the company is financially strong or not. The stock price keeps increasing enough to meet the minimum price requirement of exchange.

If you are owning a small company, that will increase the profits and sales. Then the price of stocks should continue rising after the reverse split.

The stocks that are newly listed on an exchange will attract a lot of new buyers. They will attract institutional investors who usually avoid the pink sheet stocks and over-the-counter.

The Reverse Split Prevents Major Exchange Removal

The price of shares may decline and will give low levels. The reverse split makes the shares vulnerable to further market pressure.

The exchanges generally specify the minimum bid price for those stocks that need to be listed. If the stocks fall below the bid price and also remain lower than the threshold level over a specific period. Then it will risk being delisted from the exchange.

Will Attract Big Investors

You can maintain the higher share price of your company through a reverse stock split. The reason behind this is that there are many investors and mutual funds that are having policies. These are against taking positions in stocks. These stocks are having prices below the minimum value.

If the company is free of the risk of delisting by the exchange. But still, its failure to qualify for the purchase will affect its reputation. So, reverse split here helps a lot. 

Disadvantages of Reverse Split

Suppose your stock lists on an exchange. A reverse split will here add the potential of delisting. This is the consequence of the fallen price. But if the stock remains below the minimum price of exchange. Then the stock of the company delists.

The reverse split boosts the price of the stock for the time being. But when the sales are staled or the company posts constant losses, the price of stocks will continue to fall. The stock delists off and is also left unchecked.

Conclusion

Talking about Reverse Stock Split, it can be both good and bad for a company depending upon the situation. Sometimes, it becomes favorable, while other times it causes bad impacts.

Russell Crane

Russell Crane

Russell is an Algorithmic & Technical Analyst Trader @ PatternsWizard.
His passion is to share his knowledge about TA, patterns & more. Why hope for your trading to work when you can precisely know the performance stat of every pattern?

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