Since the week has started, I've had two friends ask me about Citigroup [C:NYSE]. On Monday, my one friend thought his shares had skyrocketed ten times over the weekend, while the other, today, asked me if I had purchased any. For the record, I did own Citigroup, but sold the shares above $5 in the spring of 2010, but I digress. The move from $4 last week to $40 this week did not represent a significant rise in the company, but a reverse-split that was announced back in late March or early April. Understanding the reverse-split process is often confusing, so I am going to attempt to explain it in the simplest way possible.
A reverse split, not uncommon, is a process in which the shares of a company are moved up a factor of n with the amount of shares decreased by the same factor. In this case, Citigroup did a 10-for-1 reverse split; 1,000 shares at $4 on Friday would be show in one's account as 100 shares at $40. Note that the equity of the shares still remains at $4,000.
What does a reverse split normally entail? Many believe a reverse split could be treated as a sign that the management team lacks confidence in the share price. Stocks trading below $5 normally have a stigma associated with them, even if the company is worth billions of dollars. Companies like to have stock prices trading between $20 and $50. If the company believes the shares won't move back into that eye-catching price, they will do a reverse split.
Historically, reverse splits have not boasted well for stocks in the short term. Because of the above factor, a short-term sell off often follows, as we have already seen on the shares of Citigroup. Conversely, announcements of a stock split (where the shares are reduced by a factor and the shares are increased by the same) prove to be good ways to attract new investors into the mix and push up the price. This is because investors like to buy in board lots. If a stock is too expensive, investors are reluctant on buying 23 shares of a stock. A split would lower the cost of a board lot.
Another possible, but very unlikely, reason for the sell-off is a misunderstanding of the value of the company. People might think they have made a significant return and will sell all their shares, oblivious they own fewer shares. In reality, most brokers will have a prompt indicating they do not own 1,000 shares, unless the investor just clicked sell in their account without looking at the share count. As well, most brokers, leading up to the pay date of the new shares will have messages and notices about the reverse split. I know I did, even though I don't own the shares, so this theory is not entirely practical in today's computer world.
Option traders holding contracts should also be cautious when entering orders in. The old option chains will probably remain the same, but the new option chains might have an indicator of a stock reorganization. Although most option traders are sophisticated enough to know what the contract is, it is always safer to ensure the options are the correct strike and have the same delivery expectations.
If you are trying to sell your shares today, for unrelated purposes, check to see if the new shares are in your account. You should see a journal entry that shows a disposal of 10n shares and a purchase of n shares at the new price. If this has not happened, you may not be able to sell them because the shares in your account are not the proper Citigroup shares; they will have a different stock identification number. Again, just call your broker if you have concerns. All this should clear up by the end of the week.
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