Should I Buy Stock After A Reverse Split? – Explained

Trading stocks is trickier for common investors then we think, Short-selling, arbitrage profiteering, and investing in futures to make money even gets difficult. There are Stock Market Analysts, Broker, and agents who carry out specialized tasks for investors on stock studies.

Seeking specialists’ advice is never cheap, for a common investor that might be costly then the “spread” they wish to take advantage of.

Companies take drastic steps to improve performance from time to time, one of such tactics is a reverse stock split option. Often considered as a last resort for many ailing firms…

A reverse stock split is a total opposite to the forward or common stock split, where the company BOD decides to limit the total number of outstanding shares.

It is often calculated in large ratios of 1 for 5, and 1 for 10, so a shareholder having 10,000 shares before a reverse will hold 1,000 new shares after a 1 for 10.

A reverse stock split increases the share price as the number of outstanding shares decreases. In a few cases, small shareholders having a low number of shares (100 or fewer shares) may lose their shares with the new share percentages. Like a forward stock split, the total market capitalization of the company remains the same.

As an investor, before you decide on whether a reverse stock split is good for you, know the reasons for a reverse stock split:

  1. It is often performed to increase the share price of the company
  2. A consolidated share price would attract more investors
  3. It is performed to save the company from delisting, as a lower stock price or a penny stock gets delisted from stock exchanges
  4. SME’s listed at Over-the-counter markets may perform the reverse stock split to increase the share price sharply and get listed on the stock exchange
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So as an investor, if the company performs a reverse stock split, should you go for it? Stock prices get more affected by Stock market analysis, signals, and reputation than the actions such as a stock split.

If the management decides to perform a reverse stock split to stabilize the market share price, it generally is perceived as a good action by the analysts.

If you dig deep into the company financials, the reason for reverse stock splits is often connected with the poor financial health of the company. In that case, the management performs the tactics to save the company from delisting, which further damages its ailing reputation.

Remember, a reverse stock split is different from a stock buyback, which is a strong performing action for large firms. A large and successful firm is highly unlikely to opt for a reverse stock split; they often chose the buyback option.

Most investors take a reverse stock split as an accounting entry or as a smokescreen signal from the management, as they do not see any gains in the decision.

Penny stocks are traded at over-the-counter markets, growing companies often opt for listing at OTC markets as listing in the stock exchanges require substantial efforts and costs.

Growing companies may perform a reverse stock split to consolidate the share price and meet the prerequisite for listing in the stock exchange.

The phenomenon is rare though, as for “growing” and well-performing companies the share prices get investors’ attraction and the demand increases the share prices anyway. In either situation, if a company is moving from OTC to the stock exchange with a reverse stock split, it is a highly favorable indication to invest in such stocks.

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If the company performs a reverse stock split but doesn’t take any other corrective measures that caused the share prices to fell so low, it may be an unwise decision to invest in that stock.

If the management performs strategic corrective measures that can boost the company performance and subsequently performs a reverse stock split, the analysts may consider it is a positive signal.

Investors often lose money in a reverse stock split as the prices fluctuate drastically with the news. Stock market analysts call the reverse stock split action as the last resort before a company gets delisted, so the market signal adversely affects the share price to further slide.

As an investor, it may be an unwise decision to invest in a struggling stock, unless the company also takes other reforms to strengthen the company position. Though in accounting terms, the reverse stock split does not affect the company as the total market capitalization remains the same.