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Understanding Stock Splits and Reverse Splits

From the 1DB Trading Desk:

Understanding Stock Splits and Reverse Splits

The Stock Split:

The reasoning behind stock splits is pretty simple. When a company’s stock share price gets to be too high, the underlying company will sometimes perform a stock split to make the shares cheaper and affordable to the shareholders or potential stock buyers. This makes the company more marketable to investors that think the share price is too expensive to purchase in round lots.

EXAMPLE: in a 2-for-1 stock split, each shareholder of record receives an additional share for each share he/she holds.

Example: How does this benefit the investor?
If XYZ Corp’s shares were worth $1000.00 per share, investors would need to purchase $100k if the investor wanted to own 100 shares. This is very expensive for 100 shares of stock right?
If the stock split, and shares were now only $10.00 per share, the investor would now only need to pay $1000.00 for 100 shares. This would be a 100-1 split.

Reverse Stock Splits

A reverse stock split is the opposite of the above strategy. For EXAMPLE: In a reverse 1-for-2 split you the investor, would get half as many shares, but at twice the price. It is usually not a good sign in my experience if a company is forced to split as this would be an instant dilution of shares. When a firm performs a reverse split it is usually to make their stock appear more valuable when in fact, nothing has materially changed. Some companies may also do a reverse split to avoid de-listing.

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