What is a reverse split?
The word reverse split is used in 2 contexts – one in the running parlance and one in the stock exchange / equity market parlance.
In the running parlance it means running the second portion of the race FASTER than the FIRST portion. For example if you run 6 km in the first half an hour, and you run 7km in the second half of the hour (which means you did 13km in 1hr) you are supposed to have done a reverse split.
In the capital market / equity market, it is the reverse of split. If a company’s share (with say a face value of Rs. 10) is quoting at Rs. 7, the company may convert it into a Rs. 100 FV share. Thus if you held 1000 shares valued at Rs. 7, it will become 100 shares of Rs. 70. This is just an eyewash, and a stupid move from the shareholder point of view.
For the shareholder it adds NO VALUE at all.
Then why do companies do it?
Well, the regulators (in their unbounded, never ending fantastic wisdom) are capable of saying ‘shares below Rs. 20 will be delisted’….then such a move makes sense.
One more reason why a company could do this is to reduce speculation (sounds stupid, but if a share is quoting at Rs. 7 a lot of undesirable elements may start speculating…and create a poor image of the company.
There is no logic at all (for split or reverse split!)….but then who the hell said life is about logic?
Sambaran
Subra, you said:
“There is no logic at all (for split or reverse split!)….but then who the hell said life is about logic?”
Please help me understand about the impact of split. I thought splitting enables liquidity in stocks. If I have 7Rs, I cannot buy a stock of 10Rs. However, if the same stock is split into two, I can buy one.
IsItPossible
Not sure why would you say there is NO LOGIC for SPLIT!!!
Typically a split is done when shares are high valued in price terms so that broader masses (average retail investor can afford to buy) there by increasing liquidity (in volume terms), Isn’t it!!!
e.g. lets say a share of company ABC is currently trading at Rs.1000/- Imagine how many average people can afford to buy it? Now company decides to do a 1 to 4 split which means for every share you currently hold, you will get 4 shares and price will be Rs.250/- each. Since price per share is lower (due to split), more retail investors can participate. If company is doing well, it helps to lift the share prices thereby increasing companies market worth…
Ashish
I would doubt that companies would do it for the benefit of the retail participants. Anyway the benefit is limited – considering that majority of the shares are FV 10 at max they can have split into 1/10th of their price. If we are talking affordability of investing – a person will be able to buy 9 shares – anything above it – he could have afforded the complete unsplit share anyway.
It does decrease the minimum levels of investment required (say a stock SIP) – but i would think that its too limited to be cited as a reason for split.
Sachin
It definitively affect retail shareholders…in bad way though…if company XYZ do the split of shares. Lets say share is trading at 1 Rs, and company decided to split in 1 is to 10. So now this same share will be quoting for 10 paisa. Now people will think this will increase a trading volume but then what about brokerage ?
Brokerage is charged as percentage but with some minimum lower value say 5 paisa per share minimum. In this case brokerage will be 50% of share value. This will hamper retail participation. Sometime i really doubt on company management decisions (Do they really have brain) !!!
But as subra said “who the hell said life is about logic?”
V
Consolidation of shareholders probably?
LuckyOye
>>Well, the regulators (in their unbounded, never ending fantastic wisdom) are capable of saying ‘shares below Rs. 20 will be delisted’….then such a move makes sense.
Why only lower bound? Since their wisdom is unbounded, shouldn’t there be an upper bound as well? Like say ‘shares above Rs. 2000 will be delisted’
There are other clauses that are skewed as well…for example, to do an IPO, you must be a profitable company for the last 3 years. By that definition, if you do a loss for 3 consecutive years, you should delist yourself.
Deepak Shenoy
There is only explanation (in India) for a reverse split. Brokerage costs. Most brokers charge a min amount per share as brokerage, like Sharekhan. Which means you may minimum, say, 10 paise per share. For a share of Rs. 2, this is a 5% brokerage cost!
(Of course there is no reason Mr. Sharekhan should do that – they should charge brokerage on the total amount, but I was told that boss, this is the way they do business. They even round off the brokerage on a per-share basis, which adds a nice padding compared to rounding off the total brokerage of the transaction)
The only issue with a reverse split is: in a 1:10 reverse split, what do you do if you have 7 (or 27) shares. The partial shares are supposed to be sold and the investors paid off.