How do stock split and reverse stock split work?

What is a stock split?

The division of a company’s outstanding stocks into multiple new stocks is known as a stock split; it lowers individual share value. The commonly used stock split ratios are 2:1 and 3:1. Stock splits are also called share splits or forward stock splits.

What is a reverse stock split?

A reverse stock split is the opposite of a stock split. It decreases the total outstanding stocks of a company but increases individual share value.

Why does a company opt for a stock split?

  1. To lower the face value of a share

Usually, a company goes for a stock split when its share price is continually rising. A high price per share may dissuade investors from buying the company’s stocks as lot purchases become expensive.

  1. To boost stock liquidity

While a stock split does not alter the total market value of outstanding common stocks, a higher number of shares are floating in the stock market. Thus, stock liquidity improves. You find liquid stocks easier to trade. They minimise trade slippages too. Consequently, share buybacks become less of a hassle for companies.

When does a company perform a reverse stock split?

  1. To increase the price per share

Typically, companies experiencing continual bear runs go for a reverse stock split. They will merge multiple shares as per a predetermined ratio, thereby reducing the total number of shares floating in the market. Thus, the value per share rises. However, the total market value of outstanding shares remains undiluted.

     2. To prevent stock delisting

If a company’s stock has been underperforming for a prolonged period, the stock exchange may delist it. Moreover, institutional investors cannot purchase a stock if its price falls below a stipulated minimum. Thus, companies must maintain the price per share at a certain level.

Recent examples of forwarding and reverse stock splits

  1. Apple Inc stock split

In August 2020, tech giant Apple conducted its 5th stock split since inception. The share split ratio was 4:1, which meant that for each Apple stock worth $500 owned by investors, they got four Apple stocks with a face value of $125 each.

As of July 27, 2021, Apple Inc’s stock price is $146.77—a 17% growth in share price since the stock split. Moreover, Apple’s stock split move led to the restructuring of the Dow Jones Industrial Average Index.

2. Rennova Health reverse stock split

On July 19, 2021, US-based Rennova Health executed a 1:1000 reverse stock split, which meant that 1,000 shares of Rennova Health were consolidated into one share. As of July 27, 2021, Rennova’s Health’s share price is $0.045—an 85% drop from the pre-reverse stock split price of $0.30. Fractional shares were cash-settled.

Determining your investments based on such stock splits

Forward and reverse stock splits do not modify a company’s market capitalization, valuation, or fundamentals. Generally, stock splits invoke bullish investor sentiments, while reverse stock splits invoke bearish sentiments. When searching for stocks to buy today, it is prudent to do some research, basis on which you can take your investment decisions.

Another aspect to factor in while deciding investments is your investor profile – identifying your tolerance for risk, financial goals that you want to meet, and the investment horizon. You could also reach out to a financial advisor to guide your investments and make them work for you.

Reach out to one today!

Views:
1281
Article Tags:
Article Categories:
Finance

Leave a Reply