Reverse Splits- How Reverse Splits Work
In theory reverse splits lower the amount of operating shares (OS) creating less shares in the market. This means the share price will go up, so the shares you own will be less but the price will be higher. In the end your total ownership value should remain the same. In theory this will create more volatility in the stock price. With the hopes that the price of the shares will begin to rise more dramatically.
PENNY STOCKS AND REVERSE SPLITS:
When a penny stock does a reverse split, the same rules apply as above. They are attempting to drive the price of the stock up. Sadly in the world of penny stocks, there is a lot of deception. When I investigate penny stocks for a purchase, I take a look at the history of the stock. You can do this by viewing a companies quarterly filings.
If during an investigation of penny stock companies I notice a history of reverse splits, I immediately rule out a purchase of this stock. I’ll explain why in more detail below. Also, If i’m holding a stock and the company decides to ask the shareholders for a reverse split vote. I immediately sell. When a penny stock company runs a vote, they ensure that the majority of the shareholders are ownership and the reverse split is always in their best interest. The reverse split will be voted for and this is never good in the penny stock world.
With all stocks there are authorized shares and operating shares. Normally a penny stock performs a reverse split when they have maxed out the operating shares to the point they might not have share control during a vote. Then they can reverse split, drive down the number of shares and slowly begin dumping the extra shares into the market. This doesn’t make sense to some of you newer traders. Lets try using numbers.
Lets say a company only has Authorized Shares of 10 million. They have 5 million in operating shares already out (the float). Now they want more money, usually for their own pockets. So they reverse split and lower the operating shares to 1 million shares. The authorized shares remain at 10 million. Now they are in control of 9 million shares and in position to sell (dump) 4 million shares into the market place. This is where a bad penny stock company can make a lot of money.
When a company tries to dump this amount of shares into the market, the share price will dive and no one will want to buy the company. Now the company begins running campaigns to drive interest into their stock. Speculative news, penny stock forums and ad campaigns all help to drive volume into the stock. With volume the company can dump more shares without causing the price to drop and gaining more money for themselves.
Once this process is completed then the company repeats the process. Usually they will change the ticker symbol to make it less obvious and rely on message board misinformation to begin creating interest in their new symbol.