Reverse Stock Split: What It Is, How It Works, and Examples (2024)

What Is a Reverse Stock Split?

A reverse stock split is a type of corporate action that consolidates the number of existing shares of stock into fewer (higher-priced) shares. A reverse stock split divides the existing total quantity of shares by a number such as five or 10, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse stock split also is known as a stock consolidation, stock merge, or share rollback and is the opposite of a stock split, where a share is divided (split) into multiple parts.

Key Takeaways

  • A reverse stock split consolidates the number of existing shares of stock held by shareholders into fewer shares.
  • A reverse stock split does not directly impact a company's value (only its stock price).
  • It can signal a company in distress since it raises the value of otherwise low-priced shares.
  • Remaining relevant and avoiding being delisted are the most common reasons for corporations to pursue this strategy.

Reverse Stock Split: What It Is, How It Works, and Examples (1)

Understanding Reverse Stock Splits

Depending on market developments and situations, companies can take several actions at the corporate level that may impacttheir capital structure. One of these is a reverse stock split, whereby existing shares of corporate stock are effectively merged to create a smaller number of proportionally more valuable shares. Since companies don’t create any value by decreasing the number of shares, the price per share increases proportionally.

Per-share price bumping is the primary reason why companies opt for reverse stock splits, and the associated ratios may range from 1-for-2 to as high as 1-for-100. Reverse stock splits do not impact a corporation's value, although they usually are a result of its stock having shed substantial value. The negative connotation associated with such an act is often self-defeating as the stock is subject to renewed selling pressure.

Reverse stock splits are proposed by company management and are subject to consent from the shareholders through their voting rights.

Advantages and Disadvantages of Reverse Stock Splits

There are several reasons why a company may decide to reduce its number ofoutstanding sharesin the market, some of which are advantageous.

Advantages

Prevent major exchange removal: A share price may have tumbled to record low levels, which might make it vulnerable to further market pressure and other untoward developments, such as a failure to fulfill the exchangelisting requirements.

An exchange generally specifies a minimumbid pricefor a stock to be listed. If the stock falls below this bid price and remains lower than that threshold level over a certain period, it risks beingdelisted from the exchange.

For example, Nasdaq may delist a stock that is consistently trading below $1 per share. Removal from a national-level exchange relegates the company's shares to penny stock status, forcing them to list on the pink sheets.Once placed in these alternative marketplaces for low-value stocks, the shares become harder to buy and sell.

Attract big investors: Companies also maintain higher share prices through reverse stock splits because many institutional investors and mutual funds have policies against taking positions in a stock whose price is below a minimum value. Even if a company remains free of delisting risk by the exchange, its failure to qualify for purchase by such large-sized investors mars its trading liquidity and reputation.

Satisfy regulators: In different jurisdictions across the globe, a company’s regulation depends upon the number of shareholders, among other factors. By reducing the number of shares, companies at times aim to lower the number of shareholders to come under the purview of their preferred regulator or preferred set of laws. Companies that want to go private may also attempt to reduce the number of shareholders through such measures.

Boost spinoff prices: Companies planning to createand float a spinoff, an independent company constructed through the sale or distribution of new shares of an existing business or division of a parent company, might also use reverse splits to gain attractive prices.

For example, if shares of a company planning a spinoff are trading at lower levels, it may be difficult for it to price its spinoff company shares at a higher price. This issue could potentially be remedied by reverse splitting the shares and increasing how much each of their shares trades for.

Disadvantages

Generally, a reverse stock split is not perceived positively by market participants. It indicates that the stock price has gone to the bottom and that the company management is attempting to inflate the prices artificially without any real business proposition. Additionally, the liquidity of the stock also may take a toll with the number of shares getting reduced in the open market.

Example of a Reverse Stock Split

Say a pharmaceutical company has 10 million outstanding sharesin the market, which are trading for $5 per share. As the share price is lower, the company management may wish to artificially inflate the per-share price.

It decides to go for the 1-for-5 reverse stock split, which essentially means merging five existing shares into one new share. Once the corporate action exercise is over, the company will have two million new shares (10 million / 5), with each share now costing $25 each ($5 x 5).

The proportionate change in share price also supports the fact that the company has not created any real value simply by performing the reverse stock split. Its overall value, represented by market capitalization, before and after the corporate action should remain the same.

The previous market capis the earlier number of total shares times the earlier price per share, which is $50 million ($5 x 10 million). The market cap following the stock merger is the new number of total shares times the new price per share, which is also $50 million ($25 x 2 million).

The factor by which the company's management decides to go for the reverse stock split becomes the multiple by which the market automatically adjusts the share price.

Real-World Example

In 2002, the largest telecommunications company in the U.S.,AT&T Inc. (T), performed a 1-for-5 reverse stock split, in conjunction with plans of spinning off its cable TV division and merging it with Comcast Corp. (CMCSA). The corporate action was planned as AT&T feared that the spinoff could lead to a significant decline in its share price and could impact liquidity, business, and its ability to raise capital.

Other regular instances of reverse stock splits include many small, often non-profitable companies involved in , which do not have any profit-making or marketable product or service. In such cases, companies undergo this corporate action simply to maintain their listing on a premier stock exchange.

Why Would a Company Undergo a Reverse Stock Split?

Reverse splits are usually done when the share price falls too low, putting it at risk for delisting from an exchange for not meeting certain minimum price requirements. Having a higher share price can also attract certain investors who would not consider penny stocks for their portfolios.

What Happens If I Own Shares That Undergo a Reverse Stock Split?

With a reverse split, shareholders of record will see the number of shares they own be reduced, but also see the price of each share increase in a comparable manner. For instance, in a 1:10 reverse stock split, if you owned 1,000 shares that were trading at $5 just before the split, you would then own 100 shares at $50 each. Your broker would handle this automatically, so there is nothing you need to do. A reverse split will not affect your taxes.

Are Reverse Splits Good or Bad?

Many times reverse splits are viewed negatively, as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted. The higher-priced shares following the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices.

Why Does the ETN I Own Have So Many Reverse Splits?

Some exchange-traded products like exchange-traded notes (ETNs) naturally decay in value over time and must undergo reverse splits regularly, but these products are not intended to be held for longer than a few hours or days. This is because ETNs are technically debt instruments that hold derivatives on products like commodities or volatility-linked instruments and not the actual underlying assets.

The Bottom Line

When a publicly traded company consolidates shares, this is known as a reverse stock split or sometimes as stock consolidation, a stock merge, or a share rollback. The consolidation has no impact on a company's value. For example, if five million shares are trading at $10 per share, a 1-for-5 reverse split would result in one million shares trading at $50 per share. Reverse stock splits often are viewed negatively since it often is a means of inflating a stock's price without increasing the value of the company.

Reverse Stock Split: What It Is, How It Works, and Examples (2024)

FAQs

Reverse Stock Split: What It Is, How It Works, and Examples? ›

A reverse stock split occurs when the company reduces its number of shares while maintaining their overall value. For example, if a company offers a reverse split of 1-for-10, this means that the ten shares are converted into one share with the same overall value.

What is reverse stock split with an example? ›

A reverse stock split, as opposed to a stock split, is a reduction in the number of a company's outstanding shares in the market. It is typically based on a predetermined ratio. For example, a 2:1 reverse stock split would mean that an investor would receive 1 share for every 2 shares that they currently own.

What is a reverse stock split for dummies? ›

A reverse split takes multiple shares from investors and replaces them with fewer shares. The new share price is proportionally higher, leaving the total market value of the company unchanged.

How to make money on a reverse stock split? ›

If you own 50 shares of a company valued at $10 per share, your investment is worth $500. In a 1-for-5 reverse stock split, you would instead own 10 shares (divide the number of your shares by five) and the share price would increase to $50 per share (multiply the share price by five).

What is the work of reverse stock split? ›

When WeWork undergoes its reverse split it will be at a 1-for-40 ratio. This means there will be forty times fewer WE shares, but each share will be worth forty times as much. When will the WeWork reverse stock split happen? The reverse stock split will take place at 4:01 p.m. ET on Friday, September 1, 2023.

Do stocks go up or down after a reverse split? ›

The reverse split increases the price to a level that increases pro trading activity, often boosting the stock price higher. The stock price is below the exchange price requirement to remain listed on the exchange. Reverse splits increase price while lowering outstanding shares to maintain its listing.

Is it good to buy before a reverse split? ›

One way is to buy shares of the company before the reverse split occurs with the plan to sell them soon afterwards. This can be profitable if the company's stock price increases after the split. Another way to make money from a reverse stock split is to short sell the stock of the company.

Can you lose stock in a reverse split? ›

The reverse stock split doesn't cause investors to lose money by itself, but the move can signal to investors that the company is in financial trouble, which can lead to a sell-off. This will lower the value of the stock price, and stockholders will lose money.

Has a reverse split ever worked? ›

Reverse Splits Aren't All Bad

Sometimes companies decide to reverse split their shares just because they want to offer their shares at reasonable prices to attract new shareholders. There are examples of stocks that have prospered after doing so, including Citigroup (C).

Can a reverse stock split cause a short squeeze? ›

Several of these studies allude to the notion that reverse stock splits might attract short selling activity. Kadiyala and Vetsuypens (2002) suggest that if reverse stock splits enhance liquidity, as documented in Han (1995), both the risk of a short squeeze and the opportunity cost of a short sale are lowered.

Why do you lose money on a reverse split? ›

Many times reverse splits are viewed negatively, as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted. The higher-priced shares following the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices.

What does a 1 for 100 reverse stock split? ›

A reverse stock split may be used to reduce the number of shareholders. If a company completes a reverse split in which 1 new share is issued for every 100 old shares, any investor holding fewer than 100 shares would simply receive a cash payment.

What is a 1 for 20 reverse stock split? ›

It means that for every twenty shares you own prior to the reverse stock split, you will own one share after the split. However, each share will be worth twenty times more than it was prior to the split.

How to calculate stock price after reverse split? ›

The post-reverse split share price is calculated by multiplying by the number of shares consolidated into one share, which is ten in our illustrative scenario. Initially, the market value of your equity is worth $180.00 (200 Shares × $0.90), and after the reverse split, they are still worth $180.00 (20 Shares × $9.00).

Is a reverse stock split bullish or bearish? ›

While a standard forward stock split is generally considered bullish, a reverse stock split is typically considered bearish.

What are the disadvantages of a stock split? ›

Disadvantages of a Stock Split

A company cannot rely on a stock split to increase its value or market cap. A stock split divides the existing shares, thus keeping the market cap the same as before. Not to forget, a company must invest some amount to conduct a stock split.

What does a 4 to 1 reverse stock split mean? ›

Reverse stock split ratios: What they mean

For example, a 1-to-4 (or 1:4) reverse stock split means that a person with 4 shares now has 1, and each of those shares are now worth 4 times the previous value.

What is a 1 for 1000 reverse stock split? ›

For example, if most shareholders of a stock own fewer than 1,000 shares, the company can do a 1:1,000 reverse split and squeeze out the investors who own fewer shares by paying them for their holdings. Those shareholders would either have to accept that price or buy more shares to total 1,000.

What happens in a reverse stock split if you don't have enough shares? ›

Reverse splits also can diminish or force out small investors, who may not have enough shares to be consolidated. For example, if a company decided on a 1-for-50 reverse split, any holders of fewer than 50 shares wouldn't be offered a fractional new share. They would instead be paid cash for their shares.

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