Reverse stock splits

Q Is it OK if a company does a reverse split? — R.Y., Opelika, Alabama

A

It’s typically a red flag, suggesting that the company may be struggling and may not be a great investment. With a regular stock split, you end up with more shares, priced proportionately lower. But a reverse split does the opposite, propping up the stock price while shrinking the number of shares.

Imagine the Freerange Onion Co. (Ticker: BULBZ), which trades at $4 per share. If you own 200 shares and the company executes a 1-for-10 reverse split, you’ll end up with 20 shares, priced around $40 each. The total value of your shares remains the same — $800 — both before and after the split, just as with regular stock splits. All that happened is that the company increased its stock price by decreasing its number of shares.

Some reverse splits happen so companies can avoid being delisted from stock exchanges that require minimum price levels.

If you see that a troubled company’s stock is suddenly sporting a significantly higher price per share, know that a reverse split may have happened, not an operational turnaround. At the very least, do further research before investing in it, because many stocks’ prices continue to fall after a reverse split.

Q

In the investment world, what are “convertibles”? — H.B., Palmdale

A

They’re securities such as bonds or preferred stock that can be converted into shares of ordinary common stock — according to specified terms. They often provide more income than a common stock, and potentially more gain than a regular bond. Convertibles are complex and best avoided by beginning investors.