After understanding the intricacies and jargon of stock split in last Saturday’s blog of understanding stock split, now let us onboard on to the journey of unravelling the corporate actions further, the one term that often raises eyebrows is the "reverse stock split." So, let us dive into the world of reverse stock splits.

A reverse stock split is a corporate action in which a company reduces the number of its outstanding shares and as a result the share price increases. In other words, it is the opposite of a traditional (forward) stock split. While a regular stock split involves dividing shares to make them more affordable, a reverse stock split consolidates shares to make them more valuable. Simply put, if you have 5 notes of INR 10 each, after the reverse stock split, you will be left with only 1 note of INR 50.

Now, you might be wondering, why companies opt for this. So, Companies generally reverse split their stocks when they believe that the share price is too low. By reverse-splitting stocks and increasing the price per share, they intend to open the opportunity for investors to buy into the company.

As we understand the reason why companies do it, a thought that might be wriggling in your head would be, how we, as investors can benefit from this? So, Investors can benefit from stock splits in several manners. Here are some of the key benefits of Stock Splits:

1. Perceived Financial Health: A reverse stock split can improve the perception of a company's financial health. Shareholders often associate a higher stock price with a more stable and prosperous company, potentially boosting investor confidence.

2. Market Perception: The reverse stock split can lead to increased visibility and attention from the financial markets and media. Analysts and financial institutions may take a renewed interest in the company, contributing to a positive perception that can attract more investors.

3. Maintaining Exchange Listing: Some stock exchanges have minimum price requirements for listed companies. If a company's stock price falls below these requirements, it may face the risk of being delisted. A reverse stock split can help the company meet these listing standards and maintain its presence on major exchanges.

4. Reduced Transaction Costs: A higher stock price may reduce transaction costs for investors, as a single share with a higher value may involve lower transaction fees compared to multiple shares with lower values.

Here are key points outlining the potential disadvantages:

1. Generally, a reverse stock split is not perceived positively by market participants. It indicates that the stock price has gone to the bottom and that the company management is attempting to inflate the prices artificially without any real business proposition. Additionally, the liquidity of the stock also may take a toll with the number of shares getting reduced in the open market.

2. Costs and Administrative Burden: Implementing a reverse stock split involves administrative costs and complexities, and the process may divert management attention from core business operations.

3. Liquidity Concerns: In some cases, a higher stock price resulting from a reverse split may lead to reduced liquidity as fewer investors may be able or willing to participate in trading.

Reverse Stock split is taken as a negative signal by the street as could be seen in the case of Signet Industries Limited whose stock was split in a reverse manner in Aug’2018 in a ratio of 1:10, the stock was trading at around INR 7 before the reverse split, (technically after the split, the face value was increased to 10x, so share price should have also followed a similar trajectory) however after the split it tumbled to levels of ~INR 40 within just 5 months

With the understanding of the pros and cons of a reverse stock split, let us understand the key dates for investors for the same as well:

Announcement date: First, the company will publicly announce the plans for the reverse stock split, as well as pertinent details investors need to know. This information generally includes the ratio and when it will happen, including the record date and effective date.

Record date: This is the cut-off date to determine the eligibility of shareholders for the reverse stock split.

Effective date: The date when the new shares show up in investors' demat accounts and the shares trade on a split-adjusted basis. This may sound complicated, but it is quite simple in real-world situations. On the morning of the effective date of a stock split, the reduced number of shares will appear in your demat account, and the share price should be adjusted accordingly.

In essence, investors should be aware that while a reverse stock split may give the appearance of increased value, it does not fundamentally alter the financial health or prospects of the company. Investors need to conduct thorough research and due diligence to understand the underlying reasons for the reverse split and assess whether the company remains a sound investment.

In summary, reverse stock splits are a financial manoeuvre that can have implications for both the company and its investors. They are one of the tools companies use to manage their stock price and regulatory compliance in the dynamic world of financial markets.

To understand more about such interesting concepts along with further interesting examples, check out my course on Basics of Stock Market.

Until next time !!!