Reverse Stock Split

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Written By
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Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.

What Is a Reverse Stock Split?

A reverse stock split is a corporate action in which a company reduces the total number of its outstanding shares and increases the share price proportionally.

It is usually done to boost investor confidence or comply with exchange listing requirements.

For example, if a company performs a 1-for-10 reverse stock split, then for every 10 shares held by an investor before the split, he will receive only 1 share after the split. The value of each share would be ten times greater than before the split.

Reverse splits are generally seen as being negative events for investors because they involve reducing the number of shares you own and can lead to less liquidity in the market for its stock even though there is no change in intrinsic value.

However, some reverse splits can be seen as positive events for investors because they signal that a company’s management is taking steps to improve its capital structure and stock liquidity in some cases (by boosting it above certain prices so certain investors are allowed to buy the stock).

It’s important to note that after a reverse split the value of the company stays the same – only the share price and number of shares outstanding are affected. Furthermore, dividends are usually adjusted on a pro rata basis so shareholders will still receive the same dividend amount per their share of ownership despite owning fewer shares.


Reverse Stock Split – Key Takeaways

  • A reverse stock split is a corporate action in which a company reduces the total number of its outstanding shares by dividing each share into multiple shares.
  • Reverse stock splits are often done to encourage investor confidence and maintain the share price or raise it above certain levels, such as those set by exchanges for listing requirements.
  • Other reasons why companies may consider a reverse stock split include reducing administrative costs related to issuing and tracking smaller numbers of shares, increasing the liquidity of the shares, helping to meet regulatory requirements, and avoiding delisting from an exchange due to falling prices.
  • While investors may view reverse stock splits negatively because it has the effect of decreasing their ownership in the company, they can also be beneficial if they lead to higher share prices and increased investor confidence.
  • Companies considering reverse stock splits should consult with their financial advisors and look into the potential implications before proceeding. They should also consider other options that may be available to them, such as share repurchases or dividend payouts, which may have a less negative impact on investors. Additionally, they need to make sure they are in compliance with all applicable laws and regulations related to these transactions.


Reverse Stock Split – Good or Bad?

A reverse stock split is neither inherently good nor bad.

However, a reverse stock split is more likely to occur after a drop in the share price, which may indicate a fundamental decline in the value of a business.

Some investors are not allowed to invest in stocks that are less than $5 per share, which is often a reason for doing a reverse split.

A reverse stock split may also reduce market liquidity because it reduces the share count and makes individual shares more expensive to purchase.

For example, if a trader buys shares in standard lots of 100 shares and the stock is $5 per share, then that’s $500.

If there’s a 1:10 reverse split, then 100 shares now cost $5,000. This means that the trader may not be able to buy as many shares of the stock.

Overall, a reverse stock split is neither good nor bad in and of itself – it’s important to look at why it was done and what kind of effect it will have on shareholders before making any decisions.

It should also be noted that the effects of a reverse split are usually short-term and can be overshadowed by other events.


Reverse Stock Split


Reverse Stock Split vs Stock Split

A stock split and a reverse stock split are corporate actions that involve changing the number of outstanding shares in order to adjust a company’s stock price.

In a regular stock split, a company divides its existing shares into multiple share units of lower face value.

A reverse split, on the other hand, involves reducing the number of outstanding shares by consolidating them into fewer but higher-value shares.

Stock splits affect shareholders by adjusting the cost per share as well as the amount of voting power each shareholder has.

They do not alter total shareholder wealth or change any aspect of actual ownership by itself. Instead, they create equal percentages for all shareholders after the splitting process is completed.

Reverse splits have similar implications for shareholders: they do not receive additional shares and their voting power remains the same even though the number of outstanding shares decreases.

The key difference between a stock split and a reverse stock split is that in the former, shareholders receive more shares but each share has lower value; while in the latter, shareholders receive fewer shares but each share has higher value.

In both cases, companies adjust the existing market price to achieve balance among different shareholders.

However, reverse splits are generally seen as an attempt to boost investor confidence in a company because they tend to increase its per-share price. Nevertheless, both splits can be used by companies for various reasons depending on their particular goals or circumstances.

Additionally, it is important to note that many exchanges have certain rules for stock splits and reverse splits, so companies should be aware of applicable regulations before engaging in either type of split.


Advantages of a Reverse Stock Split

The primary advantage of a reverse stock split is that it allows companies to keep their stock prices above certain thresholds set by exchanges and other investors.

For example, some investors may not be permitted to buy shares in companies that are less than $5 per share because of regulatory reasons (such companies are considered riskier).

Additionally, it can be used as an attempt to boost confidence in the company among current shareholders and potential investors.


Disadvantages of a Reverse Stock Split

One disadvantage of a reverse stock split is that it reduces the total number of shares outstanding, which can reduce liquidity in the stock.

Additionally, some investors may be concerned by the fact that the company felt it was necessary to take such an action and may see it as a sign of financial weakness.


FAQs – Reverse Stock Split

What does a reverse stock split mean?

A reverse stock split is a corporate action in which a company reduces its number of outstanding shares by combining multiple existing shares into one.

This has the effect of increasing the share’s value. For example, if there is a 1:10 reverse split, every ten pre-split shares become one post-split share.

What impact does a reverse stock split have on shareholders?

Shareholders will still own the same proportion of ownership in the company after a reverse stock split, but their individual shareholding will decrease in quantity and increase in value.

Depending on market conditions, this could either result in profits or losses for them.

Is a reverse stock split good?

This depends on the individual investor and their goals. For some investors, a reverse stock split could be beneficial as it can potentially increase the value of their holdings.

However, for other investors, a reverse stock split may not have such a positive effect.

As always, it is important to do your own research before making any investment decision.

How to profit from a reverse stock split?

There is no sure-fire way to guarantee a profit from a reverse stock split.

However, one strategy some investors may use is to short-sell shares before the reverse stock split occurs if they believe that the market value of their shares will fall after the split (i.e., because of less liquidity).

However, this is risky and there are many factors that influence share price, so it’s important to understand the risks involved and make an informed decision.

What happens to options when a reverse stock split takes place?

Options contracts are affected by a reverse stock split too.

Your existing contracts remain unchanged but their prices adjust accordingly and you may need to adjust your trading strategies according to the new conditions.

For example, if the previous strike price of the option was $5 and there was a 1:5 split, the new strike price would be $25.

Do I lose money on a reverse stock split?

A reverse stock split simply pertains to the way ownership is divided in terms of the number of shares floated. You don’t lose money due to a reverse stock split by itself.

However, depending on market conditions and the stock’s performance after the split, you may experience a profit or loss.

Always consider any potential risks before investing in stocks.

Do all companies do reverse stock splits?

No, not all companies choose to undertake a reverse stock split. It is usually only done when a company’s share price has dropped and they want to give it a boost.

It is important to research a company thoroughly before investing in its stock as doing so can help you understand its motives for undertaking such actions better.

What are some examples of a reverse stock split?

General Electric (GE) and Annaly Capital Management (NLY) are companies that have done reverse stock splits in their history to give the share price a boost after falls in them.

How does a reverse stock split work?

A reverse stock split works by reducing the number of outstanding shares and increasing the price per share.

For example, if a company does a 1:10 reverse stock split, every ten pre-split shares become one post-split share. This has the effect of increasing the share’s value but without altering its ownership proportionately.

Should I sell before a reverse stock split?

This depends on the individual investor and their goals.

If an investor believes that a reverse stock split may have a positive effect on the company’s stock value, they may choose to hold onto the shares until after the reverse stock split occurs.

On the other hand, if an investor does not believe that a reverse stock split will have any significant impact on the share price, then they may choose to sell before it happens.

Ultimately, reverse stock splits can be a beneficial corporate action for companies looking to maintain or increase their share price, but investors should understand the potential long-term implications of such decisions prior to investing in companies that have recently undergone one.

It is also important for companies to carefully weigh the pros and cons of a reverse stock split to ensure that it is in the best interest of all stakeholders.

Understanding the potential impacts of a reverse split, as well as any other corporate actions, can help investors make more informed decisions when investing in companies.


Conclusion – Reverse Stock Split

A reverse stock split is a corporate action tool that can be used to realign the number of outstanding shares of a company’s stock with its desired capital structure.

It typically increases the share price and reduces liquidity in the short term, but can also improve long-term investor confidence by increasing the perception of financial stability.

While it should not be undertaken lightly, companies in certain situations may benefit from executing a reverse stock split.

Investors should pay close attention to announcements of this type and consider their own risk tolerance and investment goals before deciding how best to respond.

Ultimately, it is important for investors to conduct further research on any company whose board of directors proposes a reverse stock split and make an informed decision about whether or not they should continue to invest in the company.

By following these guidelines, investors can make sure they are making the right decisions for their portfolios.