Stock Market

19.

What are reverse stock splits?

For any public company, its market capitalization is the product of the number of shares of the company and the price of each share. Assume that a company has a million shares, even if the price of a share decreases by one rupee, the company loses one million market cap. In case of stock splits, the number of shares is multiplied by an integral value while the price of each share is cut down by the same. As a result, the total market capitalization remains constant. A 2-for-1 stock split is similar to exchanging a thousand rupee note for two five hundred rupee notes. The number of currency notes in one’s possession increases while individual value of the notes decreases. Stock splits may be done for various reasons: to make the stock affordable for more traders by bringing its value down or to increase the number of shares of the company in market and hence increase the company shares’ trade volume or to expedite the saturated growth since stocks of lower price are likely to be preferred more by traders or to simply please the stock holders by giving them many shares as compliment (toying with their mentality though their net holdings are the same). 

From the remark on stock splits, one may observe that it reflects a positive attitude of the company. Now there is something called the reverse stock split which is quite contrary to a stock split. Here the company issues one stock to a trader in place of ‘n’ stocks as 1-for-n, where ‘n’ is an integer. As in a forward split, the net market cap doesn’t change. The number of outstanding shares of the company is cut by a fraction while the share’s price increases by the same fraction. The main reason for reverse split is to avoid de-listing and to increase the declining share price to a more respectable value. For example, a company has totally 2 million shares and its share price is Rs.12 so that its net equity capital is Rs.24 million. Since its share price has plunged to a very low value and there is a good chance that it will be delisted from its associate stock exchange, to avoid shame the company does as 1-for-4 reverse split. Due to this, the number of shares decreases to 50000 and the share value increases to Rs.48. The equity capital remains the same.