Understanding Stock Price Drops and Reverse Split

Understanding Stock Price Drops and Reverse Split

Reverse Stock Split: A Definition

When a company's stock price drops below a certain threshold, often $1, regulatory requirements mandate that the company must take action to retain its listing status. One common method is through a reverse stock split. This action involves the company restructuring its share capital to increase the share price by merging multiple existing shares into fewer, more valuable shares.

Causes and Effects

The original share purchase of 75 shares at $100 may have been on the table at a price of $1.33 per share. However, when the stock price inevitably dropped, the company likely initiated a reverse stock split to meet the regulatory requirements.

A 1-for-5 reverse split would reduce the number of shares from 75 to 15, but at ten times the previous market price. However, the company’s failings did not improve, leading to another reverse split, turning the 15 shares into 3 shares, each valued at 5x their pre-split market price.

After each reverse split, the new value per share is recalculated, but the underlying issues usually continue. After some time, the company is likely to perform another reverse split, unless fundamental improvements are made.

Final Outcome and Compensation

Eventually, if the company fails significantly and the stock price drops again, the company may opt for a further reverse split. However, if the reverse split leaves you with fewer than one share, the company will often compensate you with a cash payment for the fractional shares. This situation often indicates an underlying issue with the company.

Company Struggles and Investor Woes

Reverse splits are often a sign of deeper problems within a company. Investing in such companies is highly risky. If you own shares in a company with a history of reverse splits, it is unlikely that the company will stabilize and rebound.

Alternative Explanations

Another explanation for the reduction in your shareholding may be due to a share consolidation. Companies facing significant losses may consolidate their share capital. In your case, 75 shares may have been consolidated into 15 or 3 shares. This is another method to drive up the share price, but it is often associated with companies in distress.

Investor Advice

Investors who bought 75 shares for $100 must be wary of such scenarios. Exotic stocks, such as penny stocks, can undergo significant changes and upheavals. You are advised to:

Check your account balance for any cash movements. Review your investment and financial situation, especially if you are on a margin account. Check your email for any broker notifications regarding margin calls or shares sold to cover debts. Stay alert for any further actions taken by the company, such as another reverse split.

Remember, when a company issues reverse splits, it often signals a steep decline and a loss of confidence among investors. It is crucial to reassess your investment portfolio to ensure it aligns with your financial goals and risk tolerance.

References

Investopedia - Reverse Stock Split Yahoo Finance - Stock Market Rules Securities and Exchange Commission (SEC) - Understanding Reverse Stock Splits