Bracket Trading Techniques

The easy way to think of a reverse stock split is to think of it as the polar opposite of a straight split. When things are going well for a company, they may decide that it is in the shareholders best interest to take their $100 stock and create twice as many shares at half the price. Thus, a straight 2:1 stock split would cut the price in half, but shareholders would get twice as many shares.

Reverse stock splits are the exact opposite in nearly every way. Companies tend to do reverse splits to boost their stock price and stave off a possible delisting from either the New York Stock Exchange or the Nasdaq. The company considering a reverse split is thus seeking to increase share price by decreasing the number of shares outstanding. For example, in a 1-for-2 reverse split, an investor with 100 shares worth $3 each will end up with 50 shares at $6. In any case, the value stays at $300.

Reverse stock splits are a survival tool used by companies that have seen share price knocked down to the single digit range. Anyone that has checked out either their 401(k), or recent stock market tables in the newspapers knows that its not just the go-go dot coms that are considering reverse stock splits. Some of the best-known brands in the world such as AT&T (T), Ericsson (ERICD) and Lucent (LU) are giving reverse stock splits serious consideration.

The minimum listing requirement for NYSE stocks is $1 a share. When AT&T shareholders approved a 1-for 5 reverse stock split in July they were in effect saying they would decrease the total shares from 3.8 billion to 760 million shares at a price five times higher than where AT&T was prior to the reverse stock split. One successful example of a reverse stock split is MicroStrategy (MSTR), which did a 1-for-10 reverse split back on July 30th, 2002. MSTR was trading for a mere $.48 a share prior to the split, which at 1-for-10 took it to $4.80. As of the end of April 2003 MSTR shares have gained nearly 800% from that level to $32 a share.