Say for the sake of the argument that 1 000 000 shares were issued during the IPO at $10 a piece. Also assume that 1 000 people bought 1000 shares each, for a total of $10 000 per person. A total of $10 000 000 were raised during the IPO, let's call that share capital.
Now the share price is $5 a piece, so the ones who bought at $10 have lost 50% of their investment. However, they still have the same amount of shares, 1000 each.
Let's assume the stock goes even further down, to say $1 each. It now becomes very impractical to trade the stock, even up or down 1 single cent immediately means 1% up or down on the share price, so the fluctuations become quite high, the share price can easily go up or down 5-10% over a day and thus becomes quite unpredictable. Such large fluctuations doesn't benefit anyone (at least not in our simplified model, I know about quantum trades and volatility trades, but let's leave that out for now). Investor want to be able to sleep at least somewhat comfortable at night and some predicatbility is desired. You wanna be able to go out for lunch without having the stock plunge 10% on you and you ending up losing money because you didn't sit at the computer.
So, we have our very low share price, of say $1. The company can then decide to do a reverse split, and say that for each 10 shares you currently have, youre going to get one new. We will simply merge ten old shares together into one new. Thus each new shares then take over the weight and value of 10 old share. So all other things equal, the new share then becomes valued at $10 and in turn each investor now only has 100 new shares.
So if a stock becomes valued too low per share, a reverse split will almost always take place to ease it's tradability and avoid to large jumps up and down.
The ultimate case is the "lottery share", a company which is on the brink of bankruptcy or have done so poor deals that it's almost completely gone and is therefore now trading at $0.01 per share. Any positive news, any little poistive signal at all will cause the share to rise, even if just a little, it will go up one cent, and thus the increase is 100%. So had you invested $1000 into one cent shares, you now have $2000.
That's basically how it works. Of course there's much more to it and ups and downs on each side, but in a simplified bare model, there it is.
Greetings to a certain girl, active on this message board, out taking care of the girls tonight. She knows who she is!
