What does a reverse stock split mean for investors?
Aug 11, 2020
Written by: Ella Vincent
A reverse stock split can benefit a corporation and an investor. This TradingSim article will explain what that action is. In addition, this article will also explain how reverse splits from large corporations benefit new investors. Also, this article helps investors to rebalance their portfolios in this bear market. This article can also help investors improve their trading strategies.
Table of Contents
What is a reverse stock split?
A reverse split is a corporation’s decision to reduce the number of its existing shares. With that action, a company splits its stock into fewer shares. Because companies sell fewer shares to investors, they enable certain actions. When a corporation has reverse stock splits, companies make their shares more valuable.
Why do companies reduce shares to sell investors?
When a corporation has a reverse stock split, there are many reasons for that decision. When a corporation’s stock falls, it’s in danger of a delistment from the New York Stock Exchange. If there’s a delistment, a stock becomes a penny stock. To avoid that fate, a company makes fewer shares available to raise the share price. Stockholders vote to approve the measure.
While corporations have reverse stock splits because of negative reasons, there are positive reasons as well. If a corporation plans to have a spinoff company, a company can reverse split its shares to increase share price. Then, a corporation can spin off into another company to gain a higher share price.
What different kinds of reverse splits exist?
Just as stocks have different prices, some reverse stock splits have different ratios. For example, a company has a 100:1 reverse stock split. In that case, every 100 shares a shareholder has converted to one share.
In one example, an investor can have 100 shares of a company at $10 a share. After a reverse stock split, every 100 shares changes to one share.
With 100,000 shares before the stock split, the market capitalization is $1,000,000. With a 100:1 split, there are now 100 outstanding shares.
The calculation is as follows:
Each share is now worth $1,000.
Does a reverse stock split affect a company’s worth?
While a reverse stock split may change an investor’s perception of a company, it doesn’t affect a company’s overall value.
Ryan Sterling is the founder of Future You Wealth in Manhattan. He noted that a company’s reverse stock split changes “are cosmetic. “They don’t say anything about the fundamentals,” added Sterling.
“Any enthusiasm you feel from a stock split, I would take with a whole lot of caution. When you talk about money in the stock market, the biggest eroder of wealth over time is human emotions,” said Sterling.
How is a reverse stock split different from a stock split?
While a reverse split means fewer shares for investors, a “regular” stock split does just the opposite. When a company takes that action, they make more shares available to investors. In a recent example, Apple recently announced it would have a stock split in August. Through a statement, the tech company made the decision to “make the stock more affordable to a broader base of investors”.
In Apple’s 4- for- 1 stock split, four shares sell for the price of one. As a result, if investors buy Apple stock at $ 400 a share. In this new 4-for-1 split, investors can buy one share for about $100.
“I was talking with a friend about a stock that he had bought at $1 per share. Shortly after he bought, the price fell to $0.50. A few months later, he received notice that the company was planning to implement a 1-for-10 reverse stock split. He was wondering if that reverse stock split was a good or bad thing,” said Matthews.
“According to the company’s press release, the reverse stock split of 1 for 10 would bring the stock price up to $5 per share, and that would prevent the stock from being delisted from Nasdaq. I ran into my friend a few weeks ago and asked about the stock. The stock, which was selling at $5.00 after the reverse, is now selling at $1.25 and he is down 88%,” added Matthews.
“In this case, the stock moving from $0.50 to $5.00 overnight was just an accounting ploy. The company still had very shaky fundamentals. Savvy institutional investors won’t invest in the stock just because its price suddenly soared, and it will have a hard time raising capital if its balance sheet is poor,” said Matthews.
“Shorters, who follow reverse stock splits and target those stocks, began to put pressure on the stock price, sending it tumbling. As selling pushed the price downward, other investors panicked and sold, causing the price to plummet even lower. As my friend discovered, a reverse stock split is normally not good news for shareholders,” added Matthews.
What should investors do when a company has a reverse stock split?
“If a stock in your portfolio announces a reverse stock split, take a good look,” said Matthews.
Matthews notes that if a corporation’s “fundamentals aren’t healthy, you might be better selling your shares. If you really like the stock, chances are good that you can buy back those shares at a much lower price several months down the road.”
However, if a company’s balance sheet and past earnings reports are strong, Matthews notes that investors should hold those stocks.
How does Apple stock split affect investors?
As a result of Apple’s split stock decision, many financial experts see it as a good sign. Caleb Silver is editor-in-chief of Investopedia. After Apple’s announcement, he believes that Apple’s decision will attract more investors to its stock.
“For popular stocks like Apple, the lower share price makes it attractive to investors who couldn’t afford higher share prices but want to own a piece of the company. Stock splits are seen as a sign of confidence from a company,” said Silver.
In addition, he added that Apple’s stock split is “considered a response to more demand for its shares from investors.”
While Apple’s stock split is gaining attention, financial experts say it won’t change the company’s value. Max Gokhman is head of asset allocation at Pacific Life Fund Advisors. He doesn’t think that the stock splits will affect its share price.
“To be crystal clear, however, and as proven by grade school algebra, stock splits have no impact on the value of a company,” said Gokhman.
“You should ignore this and instead invest in diversified stock mutual funds,” said Edelman.
Rite Aid stock rises after reverse stock split
Rite Aid (NYSE:RAD) is a company that had a reverse stock split in 2019. The pharmacy chain made the decision to avoid a delisting from the New York Stock Exchange. Rite Aid’s stock was in danger of falling below $1 before the reduction of available shares.
As a result, Rite Aid had a 1-for-20 reverse stock split. Every 20 shares of Rite Aid stock is converted into one share. The share will be 20 times the original price. While the stock briefly rebounded after the split, the coronavirus crisis caused Rite Aid shares to increase.
In addition to being part of a White House COVID-19 response group, Rite Aid is expanding its services. Many pharmacy locations will also be coronavirus testing centers.
While Rite Aid will expand services, the company noted in a statement that its “current supply of generic medications is presently sufficient and the company does not anticipate any significant near-term supply chain disruptions that will affect its ability to fill prescriptions.”
“There are certainly challenges brought about by COVID-19, including the decline in acute prescriptions and increased costs incurred to assure the safety of our associates and customers. No matter the challenge, we can execute our strategy and deliver day-to-day operational excellence in the face of a pandemic,” said Donigan.
“I am amazed by the passion and spirit of our more than 50,000 associates, who have come to work every day driven by a desire to help customers stay healthy and demonstrating the essential role of pharmacy in our communities,” added Donigan.
“Thanks to their hard work, the fundamentals of our business are strong, and we are right on track with the launch of our new RxEvolution strategy. I am excited to continue this important work as we look to become a leading mid-market PBM, unlock the value of our pharmacists and revitalize our retail and digital experiences,” said Donigan.
Rite Aid’s reverse stock split ultimately brought the corporation from the brink of bankruptcy.
Booking Holdings survives reverse stock split
Bookings Holdings(NASDAQ:BKNG) is another company that survived after a reverse stock split. When the corporation was still called Priceline, it made a decision to have a 1-for-6 split in 2003.
While the online trip booking company rebounded after its reverse stock split, coronavirus disrupted that growth. In its Q1 2020 earnings report, Glenn D. Fogel spoke about Booking Holdings’ disappointing results.
“Revenue declined 84% versus last year, and we recorded an adjusted EBITDA[ earnings before interest, taxes, depreciation, and amortization] loss of $376 million, the first time we have produced a quarterly EBITDA loss since 2001. We witnessed the greatest negative impact from the virus in April as newly booked room nights in that month declined over 85% year-over-year,” said Fogel.
“After April, room night trends have steadily improved. The improved booking trends were primarily driven by domestic travel, with international trends seeing much more limited improvement,” said Fogel.
“While almost all of our global markets showed improvement through the quarter, Europe and the United States had the highest contribution to the improved domestic booking trends,” added Fogel.
Some financial experts bullish on Booking Holdings after reverse stock split
When the U.S. State Department lifted global restrictions, Booking Holdings stock increased 1.5%. Steve Chiavarone is a portfolio manager and equity strategist and vice president at Federated Hermes. He noted that the Booking Holdings stock bump may not last because Americans are still afraid or unable to travel.
“But you still have restrictions on Americans coming in, and I think ultimately, people aren’t just staying home because of mandates. They’re staying home because they’re worried about their health,” said Chiavarone.
“I think for a lot of reasons, you’re still going to see travel levels down. I think you’re still going to see a preference for domestic travel. But, hey, incrementally, the idea that there are parts of the world that have gotten coronavirus under control enough that we can start to lift restrictions, that’s a good thing,” added Chiavarone.
Some financial experts are bearish on Booking Hearings stock
While some analysts are bearish on Booking Holdings’ stock, Broyhill Asset Management is bullish on the company’s stock. In a letter to clients, Broyhill Asset Management thinks that Booking Holdings will survive the coronavirus-caused decline in trip bookings.
“During the quarter, we also built a position in Bookings (BKNG), which we had been watching long before the crisis began. For the past three years, the stock has been under pressure due increasing concerns about the company’s competitive positioning—in relation to both hotel loyalty programs and Google’s search engine,” said Broyhill.
“And although Bookings will likely suffer in the short term, its more entrenched European business, combined with its strong balance sheet, should make it among the best-positioned companies throughout the travel sector,” added Broyhill.
While Booking Holdings has difficulty now, the reverse stock split ultimately benefited the company.
Grow Capital reduces available shares
Grow Capital(OTCQB:GRWC) is a corporation that incubates fintech companies. The company recently announced that it’s implementing a 1-for-20 reverse stock split.
The company is implementing the reverse stock split to increase its trading price to $4.00. Once the stock price reaches that threshold, it will meet NASDAQ’s required bid price. Grow’s interim CEO Terry Kennedy spoke about the changes in a statement.
“This reverse split will help GRWC normalize trading and better align with our business activity. Our subsidiary is growing and we have new acquisitions on the horizon. Issuing this reverse-split is expected to raise our per-share price and allow for better long-term planning,” said Kennedy.
“The Board believes it is in the best interests of GRWC and the stockholders to implement the Reverse Stock Split to reduce the number of our issued and outstanding shares of common stock”, said Olson.
Olson spoke about the reverse stock split “thereby increasing the number of shares of common stock available for issuance. We believe it is likely to increase the market price as fewer shares will be outstanding.”
He also noted that “the expected increased market price will encourage interest in the common stock.”
Grow Capital is another company hoping to increase its share price by reducing available shares to investors.
“As a result of the reverse stock split, every four shares of Xerox common stock issued and outstanding or held as treasury shares were automatically combined and reclassified into one share of Xerox common stock. The reverse stock split also affected all outstanding Xerox equity awards and outstanding convertible securities,” said Xerox.
What did financial experts say about Xerox’s stock split?
“So why did Xerox bother with a reverse stock split if investor wealth remains unchanged? Visibility is the answer. Many institutional investors—mutual funds in particular—ignore stocks priced in single digits. Many investment firms ignore these stocks as well. Xerox is trying to raise its profile with its reverse-stock split,” said Wyatt.
“We’re agnostic on the reverse stock split. It could raise Xerox’s standing among institutional investors and research analysts. It could also lower Xerox’s standing among other investors. Some investors are repelled by reverse stock split. They view a reverse stock split as an insincere strategy for raising the share price. Financial performance ultimately determines value and price in the long run.”
“The global COVID-19 pandemic crisis significantly impacted our second quarter 2020 revenues due to business closures and office building capacity restrictions that impacted our customers’ purchasing decisions and caused lower printing volumes on our devices,” said Xerox in a statement.
Xerox is still a viable company after its stock split, but has suffered like man companies in this current economy.
AIG rebounds after reverse stock split
AIG( NYSE:AIG) stock rebounded after collapsing during the 2008 financial crisis. The insurance company tried to recover by having a 1-for-20 reverse stock split.
“Overall, AIG reported adjusted pre-tax income of $803 million and adjusted after-tax income of $571 million or $0.66 per diluted share, compared to $1 — compared to $1.3 billion or $1.43 per share in the second quarter of 2019. The key drivers of the year-over-year reduction were higher catastrophe losses from COVID and civil unrest, along with lower net investment income,” said AIG.
While AIG persevered after 2009, the company’s still struggling during the current volatile economy.
“We delivered strong financial results on top of continued record-setting operating metrics,” said Chad Turner, Chief Financial Officer. “We generated our highest period ever of revenue from trading-related activity, which more than offset the quarter-over-quarter pressure on net interest income, given the Fed’s recent rate cuts to near zero.
“While we remain prudent on managing expenses as we navigate this low interest rate environment, we continue to opportunistically invest in sales and marketing to maintain the tremendous momentum in growth of accounts, assets, and deposits amid an environment that is particularly ripe for franchise growth,” said Turner.
“Furthermore, the blistering pace of account and asset growth continued in the second quarter, with $13.6 billion in net new retail assets, and 327,000 net new retail accounts, bringing our year-to-date retail asset flows to $31.9 billion and account growth to 656,000,” added Turner.
E-Trade stock soared after its successful reverse stock split.
“Today’s announcement marks another important milestone toward the upcoming separation that is expected to benefit Motorola, its stockholders, as well as each company’s respective customers and employees. We look forward to taking advantage of the opportunities before us as we begin the new year as two independent, publicly traded companies,” said Motorola.
Motorola suffers during global pandemic
Even though the split helped the company after the decline of its Razr phones, the COVID-19 crisis hurt Motorola as well. In its latest Q2 2020 report, the company spoke about its worse-than-expected earnings.
“Q2 results included revenue of $1.6 billion, down 13% from a year ago, including $40 million of revenue from acquisitions and $30 million of currency headwinds. GAAP operating earnings of $218 million and operating margins of 13.5% compared to 18.8% in the year-ago quarter,” said Motorola in a statement.
Despite its reverse stock split, Motorola’s stock stumbled during the COVID-19 crisis.
AT&T profits rise after reverse stock split
AT&T (NYSE:T) stock remained stable after its reverse stock split in 2002. In that split, the corporation had a massive 24,875 for 50,000 stock split.
Since that stock split, AT&T stock rose and still had a positive Q2 2020 earnings report. CEO John Stankey spoke about the results.
“Our core subscription businesses proved to be resilient in the face of the economic downturn. Our mobility and business wire line segments performed well, and we grew EBITDA[ earnings before interest, taxation, depreciation, and amortization] margins in both areas. EBITDA of $7.8 billion was up year-over-year with both EBITDA margins and service margins expanding, and that’s inclusive of COVID impacts,” said Stankey.
“Our software-based entertainment businesses performed well. ATT TV subscriber growth in its first full quarter was better than we expected and it’s our highest performing video product with customer satisfaction, double the level of our legacy TV services,” added Stankey.
AT&T stock and business division rebounded and increased after its reverse stock split almost 20 years ago.
“You guys know what the price of the stock is. It is the same price when we did the reverse split. This stock has to reach $600 for me to break even. Bring it down to $4.65 and then maybe it can climb back up to $60,” said the shareholder.
“While credit costs weighed down our net income, our overall business performance was strong during the quarter, and we have been able to navigate the COVID-19 pandemic reasonably well. The Institutional Clients Group had an exceptional quarter, marked by an increase in Fixed Income of 68%. Global Consumer Banking revenues were down as spending slowed significantly due to the pandemic,” said Corbat.
“We entered this crisis from a position of strength. During the quarter, our regulatory capital increased and our CET1 [common equity tier one capital] ratio improved to 11.5%, comfortably above our new regulatory minimum of 10%. We continued to add to our substantial levels of liquidity and our balance sheet has plenty of capacity to serve our clients,” added Corbat.
“With a sharp emphasis on risk management, we are prepared for a variety of scenarios and will continue to operate our institution prudently given this unprecedented situation,” said Corbat.
Citigroup stock flourished after its reverse stock split and help from the Federal Reserve.
Aurora Cannabis latest company to have reverse stock split
In a more current example of a stock split, Aurora Cannabis (NYSE:ACB) is implementing a 1-for-12 reverse stock split. The corporation will reduce its available shares to investors from 1.3 billion to roughly 110 million.
Despite the boom in pot sales during the worldwide quarantine, the marijuana company’s shares have plummeted. Aurora explained its decision in a statement.
“The company intends to use a portion of this available capacity to provide further balance sheet strength and preserve flexibility given macroeconomic uncertainty caused by COVID-19,” said Aurora in a statement.
What do financial experts say about Aurora Cannabis’ reverse stock split?
In response to the announcement, Innovation Shares managing director Matt Markiewicz said that Aurora had no choice but to implement the reverse stock split. Aurora stock plunged to 69 cents a share. With that disappointing share price, the stock’s in danger of being delisted from the New York Stock Exchange (NYSE).
“They had to do this to stay compliant with NYSE rules. They can’t jeopardize the U.S. because of the large shareholder base here. There’s no way the company would risk cutting that conduit,” said Markiewicz.
Jefferies analyst Owen Bennett believes that the reverse stock split will hurt investors’ confidence in the cannabis company’s stock.
“Today’s announcement of a further [at-the-market program], alongside language that suggests [how] this will be used, will be a blow to sentiment,” wrote Bennett in a note to clients.
In contrast, Cowen analyst Vivien Azer notes that Aurora Cannabis’ positive cash flow can help its reverse stock split. However, she said that she had concerns about its overall balance sheet.
She noted that the cash flow is “a positive (particularly in the current environment), but we[Cowen] continue to have concerns on the balance sheet.”
“I am incredibly proud of the Aurora team for working through these challenging times in order to maintain uninterrupted operations at all of our production facilities and ensure we continue to meet the needs of our patients and consumers,” said Singer.
“I am also pleased that our third quarter 2020 financial results were in-line with our expectations, and that we remain firmly on track with the cost-savings and capex[capital expenditure] goals we detailed during our business transformation plan in February 2020,” added Singer.
“As outlined in our press release on Friday, revenue for Q1 2020 was $58.7 million with gross profit at $10.6 million. Both of these metrics are in line with the numbers previously estimated on the year-end call,” concluded Singer.
When Aurora Cannabis has a reverse stock split, it remains to be seen how it will impact investors.
“At a Special Meeting of Stockholders today, the stockholders of Staffing 360 Solutions voted by a large margin (over 74% of outstanding shares) to provide the Board with the authority to effect a reverse stock split at a ratio in the range of 1-for-2 to 1-for-10, such ratio to be determined by the Company’s Board of Directors. After careful consideration, the Board determined the appropriate reverse stock split to be a ratio of 1-for-5,” said Flood.
Staffing 360 Solutions Q1 2020 results mixed
After its reverse stock split, Staffing 360 Solutions had a mixed Q1 2020 revenue report.
As outlined in our press release on Friday, revenue for Q1 2020 was $58.7 million with gross profit at $10.6 million. Both of these metrics are in line with the numbers previously estimated on the year-end call.
“For the first quarter of 2020, revenue of $58.7 million reflects a decrease of 20.5% over the prior year of $73.8 million,” said Viswakula.
Staffing 360 Solutions has had mixed results since its reverse stock split.
Reverse stock splits affect investors in may different ways
In reverse stock splits, many corporations have been impacted in many ways. For investors, there are different results that can affect their ability to buy shares of a company’s stock and profit after the stock splits.
If investors want more information about reverse stock splits and how they affect their portfolios, they can practice trading on TradingSim. With research and simulated trades, investors can find the best stocks that can persevere after reverse stock splits.