Stocks can make huge moves in a single day from time to time, but if you see the share price of a stock jump 1,000 percent or dip 95 percent overnight, there’s a good chance that a stock split or reverse stock split is to blame. These restructuring moves often serve as trading opportunities, but maybe not in the way you might think.
Sometimes, a company with a relatively high share price will choose to split each share of its stock into multiple shares. Companies typically choose to split their stocks when share price starts to get prohibitively high for the average investor. For example, when a stock is trading at $1,000 per share, a trader with a $5,000 trading account can’t buy a single share without devoting 20 percent of the portfolio to a single stock.
In such a case, the company may opt for a 1-to-20 stock split, which would break each share (and its corresponding stock price) into 20 parts. Instead of owning one share of a $1,000 stock, an investor will own 20 shares of a $50 stock.
It’s important to understand that no inherent value is created or destroyed via the stock split. Each share is just cut into many slices, just like how cutting a four-slice pizza into eight slices doesn’t change the total amount of pizza.
At the same time, companies with share prices that have gotten so low that they create a negative perception of the company may opt for a reverse split. As the name implies, a reverse stock split is the opposite of a forward split. A company with a share price of $0.50 may seem like a losing bet for an investor. However, with a one 20-to-1 reverse split, that $0.50 stock becomes a much more respectable $10 stock. Investors who owned 200 shares of the stock prior to the split would only hold 10 shares after the reverse split, but their equity stake in the company is not altered by the reverse split.
Reverse splits are the weapon of choice for struggling companies looking to maintain their listings on the Nasdaq and NYSE exchanges, which have $1.00 minimum share price requirements.
Stock splits and reverse stock splits don’t inherently change the value of a stock. However, they often serve as indications of the fundamental health of a company and, therefore, can be helpful buy or sell indicators.
Companies splitting shares of stock are often quality companies that have been so successful that they have outgrown their share structure. For example, Netflix, Inc (NASDAQ: NFLX), Alphabet, Inc. (NASDAQ: GOOGL) (NASDAQ: GOOG) and Apple, Inc. (NASDAQ: AAPL) are three companies that have issued stock splits in recent years. All three stocks are also up at least 50 percent in the past three years.
On the other hand, DryShips Inc. (NYSE: DRYS), Support.com, Inc. (NASDAQ: SPRT) and CTI BioPharma Corp (NASDAQ: CTIC) have all issued at least one reverse stock split in the past year. All three stocks are down more than 60 percent in the past three years. These types of struggling companies often fall into a repeating pattern of reverse splits, dilutive offerings, and declining share prices.
While there are certainly exceptions to this rule, it’s typically a good idea to sell or avoid stocks that have or are planning to execute reverse stock splits. On the other hand, companies issuing stock splits are outperforming expectations and are often among the best long-term investments.
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