Key Takeaways

  • A reverse stock split consolidates shares to boost per-share price while maintaining the same total company value.
  • Companies use reverse splits to meet stock exchange listing requirements or attract institutional investors.
  • Investors maintain the same total value initially, but can be affected by reduced liquidity or market perception.
  • Shareholders with fractional shares may be cashed out and lose ownership.
  • A reverse split can simplify the capital structure and reduce shareholder count.
  • Shareholder approval may or may not be required, depending on state law and corporate bylaws.

What is a Reverse Stock Split?

A reverse stock split is when a company reduces the total number of outstanding shares by a multiple and increase the share price by the same multiple. The company will maintain the same market capitalization (share price x outstanding shares) as before. In effect, you start out with 10 shares of stock worth $2.00 per share and assuming there is a one-for-two reverse split, you will wind up with 5 shares worth $4.00 per share. To make this easier to understand, let's assume for a moment you have two $50 bills. Someone offers you a $100 bill in exchange for them. You now have one bill worth $100 instead of two that equal the same value.

Company Value and Reverse Stock Splits

The value of a company does not change when stock splits. If a company has 100,000 outstanding shares that are worth $100 each before a stock split the company value is worth $10,000,000. If the company does a one-for-two reverse split, they now have 50,000 outstanding shares worth $200 each. The value remains the same; $10,000,000.

Why Do Companies Do Reverse Stock Splits?

Reverse stock splits increase the value of a single share of company stock. Companies that trade on the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations System (NASDAQ) often do this to show a boost in share value. This is often necessary for them to remain a publicly traded stock.

Common Triggers for Reverse Stock Splits

Reverse stock splits are often initiated when a company’s stock trades at low prices for a prolonged period. Exchanges like the NYSE and NASDAQ have minimum share price requirements (e.g., $1.00 per share for NASDAQ). Falling below this threshold could lead to delisting. A reverse split raises the share price above the minimum and allows the company to retain its listing.Other motivations include:

  • Improving stock perception: A higher stock price may imply financial stability to investors.
  • Reducing volatility: Fewer shares outstanding can reduce speculative trading.
  • Facilitating institutional investment: Many funds have policies against buying low-priced stocks.

Benefits of Reverse Stock Splits to Company

In some cases, investor may not purchase stock if they feel the price is too low. For example, some people won't buy stock priced at less than $25.00 per share. If a company stock has decreased to $12.00 per share, one option would be to do a one-for-three reverse split. Here's what happens:

  • You own 300 shares of stock at a price of $12.00 per share
  • Company announces one-for-three reverse split
  • After split you own 100 shares of stock at $36.00 per share

Now the company stock is worth $36.00 per share and more investors are likely to be interested in buying stock which gives the company more money to work with.

Strategic Advantages for Corporate Finance

Beyond improving investor appeal, a reverse stock split can:

  • Enhance eligibility for inclusion in institutional investment portfolios.
  • Signal confidence in future performance by management.
  • Improve ratios like earnings per share (EPS), which may positively affect financial optics.
  • Simplify capitalization tables by reducing the number of shares.

However, these benefits are largely optical or structural and do not directly improve company fundamentals

Do Reverse Stock Splits Hurt Shareholders?

Initially, a reverse stock split does not hurt shareholders. Investors who have $1,000 invested in 100 shares of a stock now have $1,000 invested in fewer shares. This does not mean the price of the stock will not decline in the future; putting all or part of an investment in jeopardy.

Potential Downsides for ShareholdersContent:While the total value of an investment remains unchanged immediately after a reverse split, risks include:

  • Negative market perception: Reverse splits may be seen as a red flag, particularly if done to avoid delisting.
  • Reduced liquidity: Fewer shares outstanding can make it harder to buy or sell the stock.
  • Price declines post-split: Historical trends show that companies conducting reverse splits may underperform due to underlying financial issues.

Potential Downsides for Shareholders

While the total value of an investment remains unchanged immediately after a reverse split, risks include:

  • Negative market perception: Reverse splits may be seen as a red flag, particularly if done to avoid delisting.
  • Reduced liquidity: Fewer shares outstanding can make it harder to buy or sell the stock.
  • Price declines post-split: Historical trends show that companies conducting reverse splits may underperform due to underlying financial issues.

When Shareholders May Be Hurt

In some cases, a stock split may result in fewer shareholders. For example, if a company does a reverse split of 100 shares to one, any shareholder who has fewer than 100 shares would not get a share. Instead, their shares would be exchanged for cash. For those investors, that means they no longer own a piece of a company.

Who Decides if a Stock Can Do a Reverse Stock Split?

In some cases, the shareholders may have to vote on a possible reverse stock split. However, in some states, a company's board of directors may vote for the reverse stock split without the approval of shareholders. The SEC does not dictate reverse stock splits; generally, the rules are laid out during initial stock offerings and empowers the board of directors.

What Could Happen When You Do a Reverse Split vs. When You Don’t Do a Reverse Split?

Let's make some basic assumptions to show what happens if you or don't do a reverse stock split:

  • Company is valued at $1,000,000
  • Outstanding shares 500,000
  • Shares owned by shareholders 500,000
  • Current Value of Shares $2.00
  • 50 shareholders own 1,000 shares each (50,000); 75 shareholders own 5,000 each (375,000), 1,000 shareholders own 75 shares each (75,000)

Now, let's assume the company decides on a reverse split of one-to-four and any shareholder who has fewer than 100 shares is bought out.  Here's what the change looks like:

  • Company is valued at $1,000,000 (no change)
  • Outstanding shares 125,000
  • Shares owned by shareholders 106,250
  • Current Value of Shares $8.00
  • 50 shareholders own 250 shares each (12,500); 75 shareholders own 1,250 shares each (93,750)

As you can see, the company now has 125 shareholders instead of 1,025 and has an additional 18,750 shares on their books. This means if those shares are sold, they get an additional $150,000 in capital to work with. If the company does not do a stock split, the original assumptions remain the same.

Please note, these numbers are very small for illustration purposes only. In most cases, companies will have far more issued shares.

Be Aware of Fallout After Reverse Stock Splits

Because the value of a company does not change when a reverse stock split is done, there is little downside for the company. However, it is still possible to alienate investors:

  • Eliminating Investors: If a company has hundreds of investors who own fewer than 100 shares and the stock split eliminates those investors, they may not come back. These shareholders may be upset about the split and losing their shares.
  • Causing Nervous Reactions: While a reverse stock split does not change the overall value of the company, a reverse stock split may cause some investors worries. This could result in their pulling their investment out of the company. This may cause the stock price to decline in the short-term.
  • Overpricing After Reverse Split: If a reverse split causes the stock price to increase too much investors may be discouraged. This could mean fewer investors over the short term which can mean the price of the stock could decline.

Long-Term Effects and Considerations

Reverse stock splits may have the following long-term implications:

Investor trust: If the reverse split is not paired with operational improvements, investor confidence may erode.

Dilution risk: Companies might follow a reverse split with new share issuances, which can dilute existing shareholders’ value.

Stock performance: Some studies suggest reverse splits are more common among underperforming stocks, potentially forecasting continued challenges unless accompanied by turnaround efforts.

Frequently Asked Questions

  1. What is the reverse stock split meaning in simple terms?
    It’s when a company reduces its total number of shares while increasing the value of each share, keeping the total market value the same.
  2. Is a reverse stock split good or bad?
    It depends on context—while it can help maintain stock exchange listing and improve perception, it may also signal financial trouble if driven by poor performance.
  3. How does a reverse stock split affect my shares?
    You’ll own fewer shares, but each will be worth more. The total value of your holdings remains unchanged unless the stock’s market price changes afterward.
  4. Why would a company want fewer shareholders?
    Fewer shareholders can simplify administration and help regain control over share distribution. In some cases, it helps reduce costs associated with shareholder communications and compliance.
  5. Can a company reverse a reverse stock split?
    Yes, companies may later perform a forward stock split if conditions improve, essentially undoing the consolidation.

Helpful Information

Initial NYSE Listing Standards

Initial NASDAQ Listing Requirements

Stock Split Notifications: Forms 8-K, 10-Q and 10-K

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