How Reverse Splits Effect Penny Stocks
Often times with a penny stock, a reverse split is an attempt to bring up the price of the stock.
A reverse split is when a company sets in place a new amount of shares to replace a set amount of existing shares.
As an example, a 10 for 1 reverse split would mean that the company would issue 1 share for every 10 shares that an investor holds.
The logic is that once there are only a tenth of the shares outstanding the price would increase by 10 times.
Ten old.
50 shares would now be converted into one new share worth $5.
00.
The logic seems to work out but the problem is that investors might not feel the price of the stock can be maintained at that level for long.
After all, they remember this stock trading at pennies, not a $5.
00 stock.
So the majority of times, stocks that have gone through reverse splits steadily drop in price until they trade at near what they traded for prior to the split.
Companies know that this will happen, but they move forward anyhow.
The company knows that they can only issue a certain amount of shares based on their charter.
A company that authorized 10,000,000 shares and has 5,000,000 shares outstanding can only issue another 5,000,000 shares into the market.
But what if the company was presented with an opportunity that would require 5,000,000 shares to be issued to capitalize on it? The company could do a 10 for 1 reverse split so that there would only be 500,000 shares outstanding after the split.
The company is still authorized to issue 10,000,000 shares.
Now that there are only 500,000 shares outstanding it can issue an additional 9,500,000 shares.
Before it could only issue another 5 million since it had 5 million shares outstanding.
The company at this point probably doesn't care that the price is substantially lower since it has more shares to issue to make up for the loss in price.
In these cases, investors end up losing a majority of their investment after a reverse split.
If you're holding penny stocks or have a penny stocks to watch list, be aware of reverse splits as they can dramatically affect the value of a stock.
A reverse split is when a company sets in place a new amount of shares to replace a set amount of existing shares.
As an example, a 10 for 1 reverse split would mean that the company would issue 1 share for every 10 shares that an investor holds.
The logic is that once there are only a tenth of the shares outstanding the price would increase by 10 times.
Ten old.
50 shares would now be converted into one new share worth $5.
00.
The logic seems to work out but the problem is that investors might not feel the price of the stock can be maintained at that level for long.
After all, they remember this stock trading at pennies, not a $5.
00 stock.
So the majority of times, stocks that have gone through reverse splits steadily drop in price until they trade at near what they traded for prior to the split.
Companies know that this will happen, but they move forward anyhow.
The company knows that they can only issue a certain amount of shares based on their charter.
A company that authorized 10,000,000 shares and has 5,000,000 shares outstanding can only issue another 5,000,000 shares into the market.
But what if the company was presented with an opportunity that would require 5,000,000 shares to be issued to capitalize on it? The company could do a 10 for 1 reverse split so that there would only be 500,000 shares outstanding after the split.
The company is still authorized to issue 10,000,000 shares.
Now that there are only 500,000 shares outstanding it can issue an additional 9,500,000 shares.
Before it could only issue another 5 million since it had 5 million shares outstanding.
The company at this point probably doesn't care that the price is substantially lower since it has more shares to issue to make up for the loss in price.
In these cases, investors end up losing a majority of their investment after a reverse split.
If you're holding penny stocks or have a penny stocks to watch list, be aware of reverse splits as they can dramatically affect the value of a stock.