Are Reverse Stock Splits Ever Good For Investors? When a business initiates a typical forward stock split, the market normally interprets this as a positive sign. Stock splits usually happen when a firm’s trading price rises too high, making it overly expensive for investors to purchase a board lot of shares in their preferred stock.
To counteract this scenario, companies can split their stock to lower the value of each individual share. For example, if a stock is trading at $1,000 – and a 4-for-1 stock split is performed – each share would then be worth a quarter of its previous value, or $250, after the split is closed.
While a stock split does dilute the price of a share, it doesn’t affect the firm’s overall market capitalization. This means that an investor’s total equity stake in a business is preserved, making a forward stock split non-dilutive.
In addition to a traditional split, there’s also another kind known as a reverse stock split. Again, a reverse stock split doesn’t add or subtract any value to or from a company; instead, rather than increasing the number of shares outstanding, it condenses them by a given factor. This has the effect of raising the price of each share as opposed to lowering it.
But while forward stock splits are something investors can get excited about, it’s not always the case with a reverse split. In fact, a reverse split can be a warning that a business is failing, or facing serious underlying problems.
So, let’s examine if a reverse stock split is ever any good for investors – or, alternatively, whether it’s actually a signal for potential shareholders to stay away.
Why Would A Company Perform A Reverse Stock Split?
Is a reverse stock split bad? If a company’s share price falls too low, it may be at risk of failing to meet the minimum pricing requirements for many of the major public stock exchanges. If this happens, a reverse split can help bring its price back up again, averting the imminent threat of being de-listed from the market.
However, a company whose stock has fallen precipitously low is usually a business that isn’t performing well. If this is the case, a stock split merely acts as a sticking plaster for a more fundamental issue, suggesting more significant problems for the company further down the line.
That said, this isn’t always true. Citigroup, for instance, undertook a reverse 1-for-10 stock split in 2011
, taking its shares out of the penny stock territory and bumping them up to $40 apiece. The company thrived after this measure, showing that any decision to initiate a reverse stock split should take into account all available factors.
Do Reverse Stock Splits Affect Dividends?
The total dividend payment you receive from a dividend-paying share is ultimately unaffected by any kind of stock split, either traditional or reverse.
For example, if a company distributed a dividend of $1 per share before a 1-for-3 reverse stock split, the resultant shares would be adjusted accordingly, paying out a dividend of $3 per share instead.
This would preserve the value of the overall dividend in much the same way that a company’s market capitalization is preserved when any other type of stock split is performed.
Could SoFi Benefit From A Reverse Stock Split?
One company considering a reverse stock split right now is the online personal finance business SoFi (NASDAQ:SOFI)
. The firm initially proved to be a big winner for growth investors after its SPAC merger in 2021
, but has suffered a massive 74% draw-down over the last 12 months.
Given SoFi’s current price woes, it seems reasonable that the company’s board of directors would want to give investors something to smile about. Indeed, the firm is looking for shareholders to vote on an amendment that would give it the authority to go ahead with a reverse split at some point over the coming year.
Unsurprisingly, SoFi stated that its primary reason for seeking permission for a stock split is “to increase the per share price of our Common Stock.
” This makes perfect sense – the macroeconomic situation is so unpredictable at the moment that SoFi’s share value could very well fall even further still, making it a candidate for the kind of de-listing outlined earlier.
Moreover, this would also generate greater interest in the stock, giving the company a broader appeal to a different subset of investors.
Indeed, SoFi’s price decline could lead to the perception that the company is not a viable investment security. In fact, many investors shy away from firms whose share price is abnormally low, believing that these assets are risky and speculative. For a financial services company like SoFi, that impression can have a severe impact on its reputation, driving a kind of vicious circle on both the share price and liquidity front.
It’s important to note that SoFi hasn’t indicated that it will initiate a reverse stock split yet – it just wants the option to do so if the right market conditions manifest themselves at some time in the near future. But if those conditions are amenable, a reverse stock split could be just what this company needs.
The Final Word
Do you lose money on a reverse stock split? In and of itself, a reverse stock split is neither good nor bad. Investors should analyze why a company wants to reduce its share count, and appraise the fundamentals of its business on their own merits.
However, reverse stock splits can psychologically affect investors, with sentiment turning negative if a firm announces its intention to undertake one. And not just that: if a stock split fails to arrest a pattern of price declines, those declines can further accelerate, exacerbating any underlying issues within the company, and leading to poor outcomes for its shareholders.
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