High stock prices aren't the be-all-end-all, but sometimes public companies want to increase the cost of their share price. A reverse stock split makes a stock look more expensive (even though the equity is the same). Plus, the move can even keep the security trading on a major exchange.
Here's what reverse stock splits mean and whether or not it's a red flag for an investment.
Reverse stock splits, defined
A reverse stock split occurs when a public company decreases its total number of outstanding (sold) shares and decreases the price per stock at the same rate.
Each investor's position keeps the same overall value, but the number of shares in the position decreases while the stock's price increases.
This corporate action generally requires shareholder approval.
Reverse stock split ratios: What they mean
Reverse stock split ratios help investors understand the proportion the stock is changing at. 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.
In a 1-to-3 reverse stock split, a person with 3 shares now has 1 share. Subsequently, each of those shares is now worth 3 times the previous value.
Why reverse stock splits happen
Companies perform reverse stock splits to increase the price of low-value stocks (including penny stocks). There are a couple of reasons for this:
The company wants to increase the perception of value for a low-priced stock to attract investors interested in premium offerings.
The company wants to stay on a major exchange. Whereas the UAE has the Dubai Financial Market, the US has the NYSE. The NYSE has a minimum stock price of $1 and gives warnings to companies who don't meet the threshold before delisting them.
If a company is desperate, it may perform a reverse stock split to generate buzz from analysts.
Are reverse stock splits bad news?
Reverse stock splits aren't like regular stock splits.
A normal stock split decreases the price of a high-valued stock and increases the number of outstanding shares. This can often be a good sign for prominent companies.
On the other hand, reverse stock splits are often a red flag. If a company gets delisted, you have to sell your investments in the OTC (over-the-counter) market, which is usually more volatile than the regular stock market. A company can perform a reverse stock split more than once, which would be an even bigger red flag.
As with any investment, considering the circ*mstances around the stock and overall market play a factor in your decision to buy or sell.
Examples of reverse stock splits aren't as common as cases of normal stock splits. This is because companies performing reverse stock splits tend to be smaller and less well-known. One example is Nxt-ID Inc. (NASDAQ:NXTD), which just performed a reverse stock split at a 1-to-10 ratio for Series C preferred stock.
FAQs
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 1 for 100 reverse stock split mean? ›
Example of a Reverse Stock Split
ABC Company owns 100,000 shares outstanding and announces a 100:1 reverse stock split. Every 100 shares owned by shareholders are now converted to 1 share.
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.
Is it better to sell before or after a reverse stock split? ›
The main advantage of selling before the reverse stock split is that you don't have to wait around for it to happen. However, if you want to make more money by holding onto your shares until they've risen in value again (after they've been divided), you may want to sell after the reverse stock split instead.
Do shareholders lose money in a reverse split? ›
In some reverse stock splits, small shareholders are "cashed out" (receiving a proportionate amount of cash in lieu of partial shares) so that they no longer own the company's shares. Investors may lose money as a result of fluctuations in trading prices following reverse stock splits.
Do stocks usually go up after a reverse split? ›
A reverse stock split has no immediate effect on the company's value, as its market capitalization remains the same after it's executed. However, it often leads to a drop in the stock's market price as investors see it as a sign of financial weakness.
Has a reverse split ever worked? ›
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).
How to profit from 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).
Is it better to buy stock before or after a split? ›
Does it matter to buy before or after a stock split? If you buy a stock before it splits, you'll pay more per share than what it'll cost after it splits. If you're looking to buy into a stock at a cheaper price, you may want to wait until after the stock split.
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.
Reverse stock split
A reverse split results in the reduction of outstanding shares and an increase in the price of the underlying security. The holder of an option contract will have the same number of contracts with an increase in strike price based on the reverse split value.
What happens if you don't have enough shares for a reverse split? ›
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.
Why would a company want to do a reverse stock split? ›
A company does a reverse split to increase its share price. The most common reason is to meet a requirement from a stock exchange to avoid having its shares delisted. For example, the New York Stock Exchange has rules that allow it to delist a stock that trades below $1 per share for an extended period.
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).
Will Walmart stock split in 2024? ›
30, 2024 — Walmart Inc. (NYSE: WMT) announced that it will conduct a split of its outstanding shares of common stock at a ratio of 3:1.
Has a reverse split ever helped a stock? ›
Reverse Stock Split Success Stories
Famed U.S. Government bailout candidate American International Group (AIG) was close to being yanked from the New York Stock Exchange when its stock sank below 2. The company did a 1-for-20 reverse split that sent the price above 20. Today, AIG trades at 80.
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.
Is a reverse stock split a routine matter? ›
If your shares are held in street name and you do not provide voting instructions to the bank, broker or other nominee that holds your shares, the Company expects that the Reverse Split Proposal and the Adjournment Proposal will each be treated as a non-routine matter, which means that your broker or other nominee will ...
