Let me start with this: Regular stock splits are typically a good sign. It means that the stock price for a particular company has gone up way too much. So, the board of directors decides it might be a good idea to “split” the stock price to make it more accessible for new investors. I talked about this in Lesson #36 of my first book.
For example, back in June of 2014, Apple (AAPL) did something called a 7-for-1 stock split. At that time, one share of Apple was selling for ~$700.
Let’s say you had 1 share of Apple in your investment account at $700, before the split. After the split, your investment account would show that you now had 7 shares worth $100 each.
As you can see – the actual value of the investment did not change. All that changed was the number of shares.
Now, there’s something called a Reverse Stock Split, which is typically a red flag, and you should definitely understand how this works.
Major and reputable stock exchanges such as the NASDAQ and the New York Stock Exchange (NYSE) have rules and regulations that allow companies to be listed. Being listed in any of these exchanges give businesses a certain level of “prestige” and credibility.
One of those rules for being listed in these exchanges is that the company’s stock must stay above a particular price. If it doesn’t, the company faces the risk of getting kicked out.
When a company does a “reverse split,” I see that as a desperate attempt to remain relevant when things might be falling apart.
…The reverse split is just done to make the stock price “look better.” Meanwhile, absolutely nothing about the fundamentals of the company has changed!
For the most part, this is happening because the business is struggling. As a result, the stock price might be under $1 and has remained at those low levels for longer than 30 days. When this happens, the stock exchange will notify the company that the stock price needs to go up soon.
Otherwise, they’ll be dropped, kicked out, shown the door.
Image credit: canva.com
To avoid being “kicked out” of the exchange, the company will do a reverse stock split.
For example, let’s say a company announces a “1 for 12” REVERSE stock split. This means that if you had 12 shares of that company – you’d suddenly have 1 share when the split goes through, but the price per share will be higher.
If you had 24 shares, you’d have just 2 shares at a higher price.
Some people say this feels like a “fraud,” and I agree. Although it might be a legal transaction, the reverse split is just done to make the stock price “look better.” Meanwhile, absolutely nothing about the fundamentals of the company has changed!
Although any company can decide to do a “reverse split”, my experience with investing (nearly 12 years) has shown me that this typically happens with: Penny stocks, Marihuana stocks, alleged “up and coming” biotech stocks, and speculative investments in general.
This is yet one of the many reasons why I’ve personally never put my hard earned money in those kinds of things.
If you own a stock going through A REVERSE stock spilt, you might want to take a look “under the hood” of the business and see what’s really going on behind the scenes.
Financial metrics such as levels of debt, cash, sales, and net income will tell you a lot.
TELL ME – How would YOU feel if a company in your stock portfolio announced a “REVERSE Stock Split”, what steps would you take next? Let me know in the comments.
Thanks for reading.
Cheers to HEALTH and Profits,
Courses & Resources:
Understanding Your Investing Options: Starter Guide for Beginner Investors: New to investing and not sure where or how to begin?! This guide is for you! Check out details here.
Stock Market Investing Bootcamp for Beginners: Enrollment for the next edition of this 5-week course will open soon. To be one of the firsts to be notified and to reserve your spot, make sure your name is on this list.
GOTM Investing University: Looking to learn a valuable skill during current times? Check out all the courses we have to offer.