Inside Investing | Dec 23, 2018 05:51AM ET
Investors sometimes encounter questions they aren’t sure how to answer. If you were ever stuck not knowing what happens when a stock splits, or why it was delisted, we compiled a quick and easy cheat-sheet you can use, both for yourself, or to educate others.
A stock split occurs when a company decides the value of its shares are priced too high, and they want them to feel more affordable, boosting the demand for the stock (and often raising the overall price).
When a stock splits, its value splits accordingly, so a 2-1 split means for every share you had, you now have 2, each valued at 50% the original price, a 3-2 split means for every 2 shares you’ve had, you now have 3, each valued at 66% the original price, and so on.
A reverse split is an exact opposite to a split, meaning that in a 1-10 split a trader with 1000 shares will now have 100 shares, but each share will be valued at 10-times the pre-split value. This is done when a company’s share value drops below a certain threshold and they are worried they might be delisted. If after the reverse split an investor has a number of stocks too low to reverse-split - they will receive a cash equivalent to the number of stocks they “lost”.
A trading halt is a decision made by an exchange to temporarily stop the trading of a particular stock to assure fair trading conditions or to balance buy and sell orders. Another body that can issue a trading halt is the United States’ Securities and Exchange Commission (SEC). The SEC can issue a halt for up to ten days if it considers trading a stock poses a financial risk to the public. This is usually done when a publicly-traded company fails to issue annual financial statements or their quarterly reports.
A stock is delisted when it no longer meets the exchange’s listing requirements. Exchanges have different listing requirements, such as minimal stock price, offer a minimal number of stocks, etc. Failure to meet these requirements results in the stock’s delisting from that exchange.
Delisted stocks can either be traded on the Over-the-Counter Bulletin Board (OTCBB) or via the pink sheets system. Delisted stocks also lose much of their value as the delisting results in lowered investor confidence, and is often viewed as a step towards bankruptcy.
When a stock’s value goes down to 0, the effects depend on whether you hold a long position or a short one. If you own the stock (long) - you’re investment goes down to 0 along with the stock. However, if you’re holding a short position - this is a best-case scenario, as you’ll be making 100% gains on it.
An oversold stock is one that analysts feel is being traded below its true value. This can happen when traders lose faith in the company or industry, while an experienced analyst can see the price-earnings ratio (P/E) has gone down below that of the sector or index.
An overbought stock is one that analysts feel is being traded above its true value. An overbought stock is expected to experience a correction. The best indicator here is when the P/E ratio goes above the sector or index.
Unlike physical exchanges such as Nasdaq or the NYSE, the OTC market is a network of companies that mostly trade in low-priced stocks. When a company decides to move to a major exchange it must first meet the exchange’s listing requirements (minimum stock value/quantity of available stocks, etc.).
There are different reasons why a company would choose to move to a different exchange, but the main one is to increase its visibility and liquidity.
Once a stock is added to an index, such as the S&P 500 or DJIA, its visibility, liquidity, and volume, alongside its price often increase. It also usually means another stock gets removed from the index.
When a company declared bankruptcy, it is required to sell its assets to pay off its debts. There’s an order of whom gets paid first amongst lenders:
It’s important to note that regular shareholders rarely get paid as most of the available funds go to other lenders first. If payment is still possible, a common shareholder will be compensated based on the proportion of ownership of the company’s shares.
Did you find the answers you were looking for? Is there anything else you want to know about stock behavior? Let us know in the comments below.
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