What is a Reverse Stock Split?
A reverse stock split is a corporate action that consolidates the number of outstanding shares for a publicly traded company.
This is done by dividing the total number of shares by a factor such as five, ten, or more to produce fewer, proportionately more valuable shares. A reverse stock split does not change the value of investor positions, nor does it change the market cap or valuation of a company.
Why Perform a Reverse Stock Split?
The decision to perform a reverse stock split is made by a corporation’s board of directors.
A deeply depressed share price is the most common reason companies execute reverse splits. By increasing the share price, companies can sometimes postpone or avert sell-offs that further crater the company’s share price.
Additionally, major stock exchanges mandate a minimum bid price for the stocks they list. If a company’s share price falls below this threshold, they are at risk of being delisted.
Delisted stocks are sold on over-the-counter (OTC) exchanges that do not have the same volume or interest as major exchanges, so it is worth it for companies to do what it takes to stay on major exchanges.
It is for these reasons that a reverse stock split is generally an indicator of a company that is in distress.
Investors normally see reverse stock splits for what they are—attempts by management to artificially inflate share prices without creating more business value.
What Does a Reverse Stock Split Look Like?
Let’s say that you own 4,000 shares of XYZ Corp. at fifty cents a share when XYZ announces a 1-for-10 reverse stock split. In this scenario, a new share is created for every ten outstanding shares, with the price increasing proportionally. Your portfolio would reflect the following changes.
Note that despite the sharp increase in share price, the proportionate reduction in the number of shares you own means that your position size, at the time of the reverse split, remains the same.
Investors who hold an odd number of shares not easily divisible by the reverse split factor can find themselves left with fractional shares, or portions of whole shares. Depending on the brokerage, these fractional shares may be immediately sold and the account credited with the proceeds of the sale, or they may be added to the total position size as portions of a whole share.
What Is a Stock Split?
A stock split is the opposite of a reverse split.
Instead of consolidating shares to artificially drive up share prices, a stock split multiplies the number of outstanding shares by a factor of two, three, or more to increase the number of shares and push the share price down.
This is often done to improve liquidity and increase the access that smaller retail investors have to a share price that has grown too high too fast.