What is a Reverse/Forward
Split?
Date Added: March 28th,
2006
By Chris Stallman
| E-mail
"A company I recently
invested in had a reverse/forward split and they gave me all of my
money back. What did this mean?" - Marcus (East Lansing,
MI)
This is a great question because reverse/forward
splits are both relatively unknown forms of stock splits and controversial
at the same time. We're not exactly sure when these originated
but they've arguably become more popular in recent years.
In short,
a reverse/forward split is exactly as its name indicates: it's a
reverse stock split followed by an immediate forward stock split.
It effectively "cashes out" small investors who own fewer than 100
shares. This is how it works and why it's so controversial:
How a
Reverse/Forward Split Works
Its name describes exactly what it does--a reverse/forward
split begins with a reverse split and is immediately followed by
a forward split. For example, companies will begin it
with a 1-for-100 reverse split where each 100 shares of
stock that a person owns will be converted into 1 share
of the new stock. Then, they'll be converted right back
into the same form as their original shares via a
100-for-1 forward split.
So if you end up with the same number of shares of
stock at the same price as you did before, why do it?
Well, if you own fewer than 100 shares of stock, you
can't participate in this because you will not qualify for
at least 1 share of the new stock through the first step (reverse
split). This means that the company will cash
out any investors who own fewer than 100
shares--meaning you will be given cash in exchange
for your stock.
Arguments for Them
Many companies argue that reverse/forward splits allow
them to save money. After all, they will no longer spend time
and money mailing out proxies and servicing their smaller shareholders.
In fact, Arlington Hospitality estimated that its 2003 reverse/forward
split saved it approximately $25,000/year in administrative costs.
Arguments Against Them
Reverse/forward
splits have become a relatively contentious topic in finance because
of their ramifications: they basically show that small investors
don't matter to companies. If every company in the country
did this, small investors everywhere would be effectively forced
out of their investments. This does not exactly reflect well
on a democratic society.
It's important to note that many companies (for example,
Disney) appreciate small shareholders and view them as valuable
repeat customers. They welcome investors who may only own
one share of stock because it creates brand loyalty and gives them
a way to keep their customers interested.
In the grand scheme of things, though, these reverse
splits don't matter all that much. If you were "cashed out"
of your holding, you can immediately repurchase the new shares and
get back in. Even though they don't matter all that much,
it'll be interesting to see where this new form of stock split goes
in the future.
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