What does a reverse stock split usually signify about a company?
According to Investopedia, a reverse stock split may signify a company is in distress since it raises the value of otherwise low-priced shares.
A reverse stock split is a strategy corporations may take in order to stay relevant and avoid being delisted.
It does not directly impact the value of the company, only its stock price.
Depending on market developments and situations, companies can take several actions at the corporate level that may impact their capital structure.
One of these is a reverse stock split, where existing shares of corporate stock merge to create a smaller number of proportionally more valuable shares.
Since companies don’t create any value by decreasing the number of shares, the price per share increases proportionally.
Despite the strategy having a negative connotation, there are a few advantages behind a reverse stock split.
Prevents Major Stock Exchange Removal
When a company’s stock tumbles extremely low, they face the consequence of being delisted.
A reverse stock split puts a company in a ‘safe zone’ by raising its share price through the merge of various shares without necessarily increasing its value.
An exchange typically specifies a minimum bid price for a stock to be listed.
If the stock falls below this bid price and remains lower than that threshold level over a certain period, it risks being delisted from the exchange.
This strategy buys company’s time to pivot as they assess what areas need to be worked on.
A Reverse Stock Split May Attract Bigger Investors
One of the positives of a reverse stock split is that it may attract big investors who wouldn’t otherwise invest in ‘penny stocks’.
A penny stock refers to a small company’s stock that typically trades for less than $5 per share.
Some institutions have policies that prohibit them from taking positions in company’s whose price is below a specific value.
Generally, a reverse stock split is not perceived positively by market participants.
It indicates that the stock price has gone to the bottom and that the company management is attempting to inflate the prices artificially.
Additionally, the liquidity of the stock may also take a toll with the number of shares getting reduced in the open market.
While a reverse stock split may increase a company’s share price, market participants may experience drawdown due to lack of liquidity and demand at higher share prices.
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