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What is a Reverse/Forward Stock Split?

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.

Discuss It!
1 2 >

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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.

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