Reverse Stock Split

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What is a 'Reverse Stock Split'

A corporate action in which a company reduces the total number of its outstanding shares. A reverse stock split involves the company dividing its current shares by a number such as 5 or 10, which would be called a 1-for-5 or 1-for-10 split, respectively. A reverse stock split is the opposite of a conventional (forward) stock split, which increases the number of shares outstanding. Similar to a forward stock split, the reverse split does not add any real value to the company. But since the motivation for a reverse split is very different from that for a forward split, the stock’s price moves after a reverse and forward split may be quite divergent. A reverse stock split is also known as a stock consolidation or share rollback.

BREAKING DOWN 'Reverse Stock Split'

If a company has 200 million shares outstanding and the shares are trading at 20 cents each, a 1-for-10 reverse split would reduce the number of shares to 20 million, while the shares should trade at about $2. Note that the company’s market capitalization pre-split and post-split should – theoretically at least – be unchanged at $40 million.

But in the real world, a stock that has undergone a reverse split may well come under renewed selling pressure. In the above instance, if the stock declines to a price of $1.80 after the reverse split, the company’s market cap would now be $36 million. Conversely, with a forward split, the stock may gain post-split because it is perceived as a success and its lower price might attract more investors.

In the vast majority of cases, a reverse split is undertaken to fulfill exchange listing requirements. An exchange generally specifies a minimum bid price for a stock to be listed. If the stock falls below this bid price, it risks being delisted. Exchanges temporarily suspend this minimum price requirement during uncertain times; for example, the NYSE and Nasdaq suspended the minimum $1 price requirement for stocks listed during the 2008-09 bear market. However, during normal business times, a company whose stock price has declined precipitously over the years may have little choice but to undergo a reverse stock split to maintain its exchange listing.

A secondary benefit of a reverse split is that by reducing the shares outstanding and share float, the stock becomes harder to borrow, making it difficult for short sellers to short the stock. The limited liquidity may also widen the bid-ask spread, which in turn deters trading and short selling.

The ratios associated with reverse splits are typically higher than those for forward splits, with some splits done on a 1-for-10, 1-for-50 or even 1-for-100 basis.

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RELATED FAQS
  1. What are reverse stock splits?

    A reverse stock split is a corporate action in which a company reduces the number of shares it has outstanding by a set multiple. ... Read Answer >>
  2. How does a company decide when it is going to split its stock?

    Learn why some companies decide to split their shares, and understand how they think it helps the stock's liquidity and future ... Read Answer >>
  3. What happens to the value of a mutual fund when a stock splits?

    Find out what happens to the value of a mutual fund when a stock in its portfolio splits, including how stock splits work ... Read Answer >>
  4. How long does a stock that has done a reverse split keep the letter "D" at the end ...

    A reverse split is a corporate action whereby a company reduces the number of shares outstanding and increases the price ... Read Answer >>
  5. Why would you undertake a reverse split?

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  6. Where can I find out about upcoming stock splits?

    Learn what a stock split is, how it is accounted for and where to find upcoming information about stock splits on the Internet. Read Answer >>
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