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Why Companies Use Reverse Stock Splits
By JLP | November 26, 2007
While working on another post, I came across Doral Financial, a company whose stock was trading at $2.87 on December 29, 2006. Today it’s trading at $18.70. At first glance that looks like a stellar rate of return so far this year.
You would be wrong.
Why?
Because on August 17, 2007, with the stock trading at just $.88 per share, the company did a 1-for-20 REVERSE stock split. As you can probably tell from the word “reverse,” a reverse stock split is the opposite of the kind of stock splits that most of us are used to. In most cases, companies do a stock split in order to reduce the price per share (you get more shares but the shares are worth less). A reverse stock split is done to increase the price per share (you get less shares but the shares are worth more).
Here’s an illustration:
On January 1, 2007 your investment in Doral Financial would have looked like this:
1,000 shares × $2.87 = $2,870
On August 17, 2007, right before the split, your investment would have looked like this:
1,000 shares × $.88 = $880
Right after the split, your investment would have looked like this:
50 shares × $15.00 = $750
As of this writing, 50 shares would be worth $935, which is still way below the value at the beginning of the year.
So, why did this company do a reverse stock split? Because it is embarrassing for a company to have a stock price that is below $10 per share. Imagine how this company felt with their stock trading below $1 per share! In addition to the embarrassment, institutions won’t consider investing in a company whose stock price is so low.
Finally, one thing I found kind of funny when putting this post together is this statement I found on the Doral Financial website:
LOL! They clearly aren’t meeting their lofty goals.
Topics: Investing | 5 Comments »
November 26th, 2007 at 5:25 pm
take it to the bank. if you own a stock which reversed split, sell it yesterday.
November 26th, 2007 at 5:31 pm
Don’t forget, sometimes they can do a reverse split just to keep their listing. Locally, Savvis Communications (SVVS?) did a reverse split a couple years ago to stay on NASDAQ. They’ve done quite well since, but not related to the reverse, just normal business.
November 26th, 2007 at 7:59 pm
I think it’s folly to try to draw any conclusion from a stock split (or reverse split). If the company explains why it’s doing it, then that explanation might be useful information. If they don’t explain it, then any conclusion you draw is likely to be wrong.
If you really want to research a company, there are 100s of more important things to look at than an issue like this.
November 26th, 2007 at 8:12 pm
what causes the drop in total ownership after the split? if they turned 1000 shares into 50 shares, the total value should have ended up the same, right? so each share should have been worth 17.60 after the split, not 15.00. or am I missing something?
November 27th, 2007 at 4:43 pm
My understanding is that reverse splits usually aren’t as much a ‘marketing gimmick’ as regular splits. Companies need to reverse split to encourage trading in their shares. Having a higher trading volume and having a share price over a certain price (usually $1.00 for the Nasdaq) keep shares properly listed so they aren’t delisted and moved to the pink sheets or some other less desirable exchange.