Reverse splits are not popular as a stock split, but it is an important corporate action you should know about.
What is a Reverse Stock Split?
Reverse stock splits are a complete opposite of a stock split. In a stock split, a big share is split into biteable pieces. Conversely, in a reverse stock split, small shares are merged to form a big share.
When a company goes through a reverse stock split, the number of shares an investor holds reduces, but the final value of the shares remains the same.
Why Does a Company Decide to Undergo Reverse Stock Split?
Attract Big Investors
The primary motive of undergoing a reverse stock split is to attract institutional investors and mutual fund companies to invest in the share.
Now, when a share price plunges under a certain value and mutual fund companies, or big investors might not prefer investing in such a company.
Hence, to make the company’s share price look lucrative, a company decides to undergo a reverse stock split.
Minimum Share Price Requirement
There are a few stock exchanges with a regulation; to list a company on the stock exchange, it needs to have a minimum share price and a certain number of shares. So, when a company is heading towards the minimum share price, it undergoes a reverse stock split to avoid delisting.
What is the Impact of Reverse Stock Split on Your Portfolio?
Practically, there is no impact of a reverse stock split on your portfolio apart from the change in the number of shares you hold and the change in the face value. The value of your investment would remain the same.
Investors usually think that a reverse stock split is a way of artificially increasing the share price; hence, they tend to sell the share before the stock split. But that’s a misconception.
A reverse stock split should not be a parameter of selling a share. Instead, if you know that you have invested in a fundamentally strong company, you must stay invested. These corporate actions should not influence your decision to sell a share.
(The author is Founder, TejiMandi)