How to Profit From a Reverse Stock Split?

A reverse stock split occurs when a corporation decides to reduce the number of its outstanding shares. This action doesn’t affect the company's total market value but instead consolidates existing shares into fewer, higher-valued ones.

At first glance, this might seem like a straightforward swap—akin to trading two $50 bills for a $100 bill. However, some investors view reverse stock splits as red flags, suggesting that the company may be attempting to artificially boost its stock price rather than improving its underlying business performance.

Yet, if a reverse stock split coincides with other strategic changes that enhance value, it could signal a positive shift in the company’s direction. When evaluating a company that has undergone a reverse stock split, it's important to consider these broader strategic contexts below.

How does Reverse Stock Split Work?

A stock split increases the number of shares available for trading but does not alter an investor's proportional equity in the company. For instance, if you hold 100 shares of XYZ stock and the company carries out a two-for-one split, you will then own 200 shares. Concurrently, the price per share would halve. Thus, if your shares were initially valued at $100 each, they would be worth $50 each post-split.

Conversely, a reverse stock split consolidates shares and reduces the total number available. Companies can apply various ratios for this process. For example, a company might enact a reverse split where every 10 shares are merged into a single share. If you owned 100 shares before such a split, you would have 10 shares afterward.

The price per share would adjust accordingly. If a share was priced at $10 before the reverse split, it would escalate to $100 afterward. The total value of your investment remains the same, at $1,000; the primary change is in the number of shares you hold.

Reasons Why Companies Perform Reverse Stock Splits

Reverse stock splits are a strategy used by companies to manage their stock prices and market perception. Here are detailed reasons why companies might choose to perform a reverse stock split:

Meet Stock Exchange Listing Requirements: Many stock exchanges, including major ones like Nasdaq, have minimum bid price requirements. If a company’s stock price falls below this threshold, it risks being delisted. A reverse stock split increases the per-share price, helping companies comply with these requirements and maintain their listing status.

Improve Market Perception: Low stock prices can be associated with financial instability or poor company performance. By increasing the stock price through a reverse split, companies may improve their market perception, making their stock appear more valuable or stable.

Attract Institutional Investors: Institutional investors often avoid stocks priced too low due to perceived risks or the inability to trade large volumes without impacting the price. A higher stock price, achieved through a reverse split, can make the stock more attractive to institutional investors and large funds.

Reduce Volatility: Lower-priced stocks can be more volatile and susceptible to price manipulation. By consolidating shares and increasing the stock price, a reverse stock split can potentially reduce the volatility associated with stock.

Strategic Corporate Actions: Companies planning to create spin-offs or undertake other strategic corporate actions might use reverse stock splits to ensure the resulting entities have attractively priced shares. This can make the new shares more appealing to investors.

Extend the Life of the Stock: In some cases, a reverse stock split might be used as a strategy to extend the life of a stock that is slipping in value and visibility in the market. This can give the company time to restructure and attempt a turnaround.

However, if the company fails to enhance its operations in conjunction with the reverse stock split, its stock price may continue to decline, further increasing concerns about the company’s future stability.

Should I Sell Before a Stock Split?

Deciding when to sell a stock involves numerous factors, and determining whether to sell before or after a stock split depends on various signals about the company's financial health and anticipated post-split performance.

Investors holding shares in a company with a strong overall track record might opt to stay invested. While a split might temporarily lower the share price, their investment could appreciate if the stock price continues to rise post-split.

For a reverse stock split, the decision to sell or hold often rests on the reasons behind the split. If the company is conducting a reverse stock split to elevate share prices and attract new investors, it's crucial to understand the objectives driving this strategy.

Analyzing the company’s financial statements and assessing metrics such as the price-to-earnings (P/E) ratio, earnings per share (EPS), and other vital ratios highlighted in the company’s earnings report can provide clearer insights into the potential future trajectory of the stock.

Recent Examples of Reverse Stock Splits

Phunware, Inc. (NASDAQ:PHUN)

  Details: Phunware completed a 1-for-50 reverse stock split. This was done to artificially boost the share price to meet listing requirements, as the company has been unprofitable with fluctuating revenues.

  Date: Effective as of February 2024.

Lytus Technologies Holdings (NASDAQ:LYT)

  Details: Lytus Technologies announced a 1-for-60 reverse stock split. The primary reason for this reverse split was to maintain its listing on Nasdaq.

  Date: Effective from February 23, 2024.

Bio-Path Holdings (NASDAQ:BPTH)

  Details: Bio-Path announced a 1-for-20 reverse stock split. This adjustment was also aimed at compliance with Nasdaq listing requirements.

  Date: Effective from February 23, 2024.

Vaccinex, Inc. (NASDAQ:VCNX)

  Details: Vaccinex implemented a 1-for-14 reverse stock split. This was primarily to comply with the $1.00 minimum bid price requirement of The Nasdaq Capital Market.

  Date: Effective from February 20, 2024.

Shineco, Inc. (NASDAQ:SISI)

  Details: Shineco approved a 1-for-10 reverse stock split. Similar to others, this was to regain compliance with Nasdaq's minimum bid price requirement.

  Date: Effective from February 16, 2024.

Precision BioSciences, Inc. (NASDAQ:DTIL)

  Details: Precision BioSciences announced a 1-for-30 reverse stock split. The split was part of efforts to adjust the share price for better market compliance.

  Date: Effective from February 14, 2024.

Wrapping Up

Investors may occasionally encounter stock splits. Understanding the implications of both forward and reverse stock splits, and what they can indicate about a company's health and strategy, can aid investors in developing effective management tactics for such events.

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