The Effect Of AIG’s Reverse Stock Split

The approval of a 1:20 reverse stock split is bringing AIG back into the headlines. The stock appears to be up 1,500 percent today. Don’t get excited, a reverse stock split took effect yesterday at 5 pm. What is a reverse stock split and should it mean anything to investors?

As an investor, a stock split or a reverse stock split does nothing for your overall position. Let’s take a look at both.

Photo by Barrybar, courtesy of flickr

In a normal stock split, the number of outstanding shares is increased, typically by a 2:1 ratio. So, for every one share you owned prior to the split, you will own two after the split. However, since the number of shares doubled, the value of each share is now cut in half.

Cutting the shares in half maintains the company’s market capitalization and the size of your investment.

Think of it as taking two fifty-cent pieces to the bank and asking for four quarters. Even though you end up with more coins, you still have one dollar.

In the case of a reverse stock split, the number of outstanding shares is decreased and the value of each share is increased. So if you had ten shares worth a total of $100 prior to a 1:2 reverse stock split, then you will have five shares worth a total of $100 after the split. Each share has gone from $10 to $20 in value, but the overall value of your holdings remains unchanged.

Shares of AIG closed yesterday at $1.16 per share and are currently trading around $18 each, which is less than 20 times the pre-split price. Each share of AIG’s stock is now more expensive, and there are now fewer shares available, but the market capitalization has actually declined.

The bottom line: If a cake tastes bad, it doesn’t matter how you slice it.