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Is reverse split good or bad?


Reverse stock split reduces number of outstanding shares in a predetermined ratio. It is also known as stock consolidation, share rollback or stock merger because two or more shares are merged into one more valuable share. Reverse split is considered to be a corporate action, meaning action that is affecting share price and needs to be approved by the company's board of directors and possibly by voting shareholders. Company can even get additional letter D to its ticker signifying that it is going through reverse split.

Number of total outstanding shares, which includes shares currently held by all shareholders, including institutional investors and restricted shares, is usually divided with 5 or 10 getting ratio one for five or one for ten but it can be as little as one to two or big as one to hundred. For example if you have 100 shares worth $1 each so you have $100 worth of shares. if a company is going for one for then reverse split, you will receive ten shares, each worth $10. As you van see no real value is added with this action, you still have the same $100 worth of shares, you just hold fewer but more valuable shares; market capitalization is the same.

The question is why the company chooses to do the reverse split and what are the repercussions of such action. The most common scenario is that company is trying not to get delisted from a stock exchange that have minimum bid price requirements. Nasdaq for example will delists companies that trade below $1 for certain period of time. If that happens only place to trade the stock is over the counter market (OTC) in penny stock section. There is prestige that comes with being listed on a major exchange and it certainly attracts many institutional investors and mutual funds so it is easy to understand why company doesn't want to lose that status. With reducing number of shares comes the reduction of number of shareholders which can be useful if company needs to reduce that number for certain regulation or if a company wants to go private.  If you have a public company you naturally want to draw positive attention and attract as many shareholders as you could. Having stock that that is on a higher price side will draw more attention from analysts an subsequently investors. Typically, share price must be above $5 for options to be traded on the stock.

Reverse stock split can be considered as a sign of a struggling company that is trying to avoid delisting but it can be used in a positive way to help company transition to trading on exchange.Smaller number of shares are certainly more appealing to investors in contrast to stock split which dilutes their ownership. If investors perceive it negatively, nothing more than a smoke screen share price can drop to initial value. In case that reverse split is accompanied by positive changes in corporate structure and strategy there is a chance that company is on a good path.
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