Why Would a Company Perform a Reverse Stock Split?

Updated April 30, 2023

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What Is a Reverse Stock Split?

A reverse stock split is a measure taken by a public company to reduce its number of outstanding shares in the market. Existing shares༺ are consolidated into fewer shares. This results in a higher stock price for the stock shares, but it has no immediate effect on the total value of the stock to the investor—or 🌸the market capitalization of the stock.

For example, if a stock is t🎉rading at 50 cents on the market—and the company declares a two-for-one reverse stock split—then an investor who owned 100 shares worth 50 cents would own 50 shareౠs worth $1 each.

Reverse Stock Split in a Nutshell

A reverse stock split is a type of 澳洲幸运5官方开奖结果体彩网:corporate action that consolidates the number of existing shares of stock into fewer—and thus, higher-priced—shares. A reverse stock split divides the existing total quantity of shares by a number such as fi⛄ve or 10, which w♈ould then be called a 1-for-5 or 1-for-10 reverse split, respectively.

Key Takeaways

A company may perform a reverse stock split to boost its stock price by decreasing the number of shares outstanding.
A reverse stock split has no immediate effect on the company’s value because its market capitalization remains the same after it’s executed.
However, a reverse stock split often leads to a drop in the stock’s market price because investors may perceive the action as a sign of financial distress.
A company may pursue a reverse stock split to prevent its stock from being delisted or to improve a company’s image and visibility.

How a Reverse Stock Split Works

When a reverse stock split is executed, a company cancels its current outstanding stock and distributes new shares to its 澳洲幸运5官方开奖结果体彩网:shareholders—in proportion to the number of shares they owned before the reverse s💟plit.

For example, in aꦉ one-for-ten (1:10) reverse split, shareholders receive one share of the company’s new stock for every ten shares they owned previously. Each new share would be worth ten times that of the shares before the split. A shareholder who held 1,000 shares would end up with 100 shares after the reverse stock split was complete. (The process is the reverse in a stock split. Each stockholder receives two or more shares for every share held at the time of the split.)

A reverse stock split has no immediate effect on the company’s value because its total 澳洲幸运5官方开奖结果体彩网:market capitalization remains the same. It has no immediate effect on the value of the stock to the investor, either. However, a reverse stock split is often unwelcome news to the investor because it is seen as a sign that the company is in financial trouble. Some loss in 澳洲幸运5官方开奖结果体彩网:market value often follows a reverse stock split as investors unloa🐷d their shares.

This practice doesn't reward investors at dividend time, either. If the company pays cash 澳洲幸运5官方开奖结果体彩网:dividends, future dividends would be adjusted to reflect the new, lower number of shares outstanding. So, if a company pays its shareholders𒁏 a $1-per-share dividend—and it undergoes a 1:5 reverse split—the dividend becomes $5𒁃 per share (or five times the old payout). So, the dividend payment is unchanged.

Reasons for a Reverse Stock Split

There are a number of reasons why a company may decide to execute a reverse stock split and reduce its number of outꦚstanding shares in the market. Here are the main motives:

Prevent delisting: If a stock price falls below $1, it is at risk of being delisted from stock 澳洲幸运5官方开奖结果体彩网:exchanges that have minimum share price rules. The company’s shares then enter penny stock territory and can only be bought and sold as over-the-counter stocks.
Boost the company’s image: A stock that trades in single digits is generally viewed as a risky investment. A reverse split gives the spurious appearance of a more valuable stock.
Increase interest in the stock. Higher-priced stocks attract more attention from market analysts and more coverage by the business news media. A company that is ignored by analysts and the media is likely to fall into obscurity.
Increase trading in the stock. Many institutional investors and mutual funds do not invest in stocks worth less than a set price—often $1 or less. Boosting the stock price, even artificially, can increase purchases of the stock.

Criticism of a Reverse Stock Split

Reverse stock splits carry a negative connotation. Companies that need to go through a reverse stock split to boost their share price🥃 risk alienating their current investors. New investors may not be impressed, either. They might believe the company is struggling and view the reverse split as an accounting gimmick.

Is a Reverse Stock Split Ever a Good Thing?

Absolutely. Some companies have survived and thrived after going through a rough patch that led to a reverse stock split. They tend to be well-known companies that have been underperforming recently and want to raise their profiles. They bet on a reverse split as a way back into the limelight. AIG (AIG), Motorola (MSI), and Xerox (XRX) are all companies that have executed reverse stock splits.

Are Some Sectors Prone to Reverse Stock Splits?

Reverse stock splits tend to occur in sectors that are highly volatile, even beyond the usual ups and downs of the market. Many of the stocks in those sectors are considered speculative, even in the best of times. Examples of industries more prone to reverse stock splits are the biotechnology, technology, and mining sectors.

Which Is Better, a Stock Split or a Reverse Stock Split?

In general, investors love 澳洲幸运5官方开奖结果体彩网:stock splits and loathe reverse stock splits. Both are entirely artificial moves because they have no immediate effect on a company’s real market value or a 澳洲幸运5官方开奖结果体彩网:stock’s real value. On the other𒐪, stock splits tend to spur additional market gains for the stock. And, the happy investor’s stake has multiplied at no additional cost. Reverse stock splits signal a company’s struggle to maintain (let alone grow) its stock price. Stock splits signal a company’s desire to keep the price of a single share within the reach of more investors.

The Bottom Line

Reverse stock splits are generally received with skepticism, if not downright pessimism, from investors. They are ꦯseen as a sign that a company is in financial trouble and sees boosting its stock price artificially as the only way out. They’re not wrong, but in fact, seওveral companies have been forced to reverse-split their stocks during a bad stretch, only to make a genuine comeback in market value over time.

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