Reverse Stock Split

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DEFINITION of '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.

INVESTOPEDIA EXPLAINS '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. How do you calculate a reverse split using Excel?

    A reverse stock split is a corporate action a company may take to meet exchange requirements. A reverse split reduces the ... Read Full Answer >>
  2. What is the effect of a reverse split on the stock's value?

    When a company executes a reverse stock split, the stock's value increases by the multiple by which the company is reduced. ... Read Full Answer >>
  3. How is a company's market capitalization affected by a reverse stock split?

    A company's market capitalization is theoretically unaffected by a reverse stock split. A reverse stock split is a corporate ... Read Full Answer >>
  4. What are the typical ratios for a reverse stock split?

    Common share swap ratios used in a reverse stock split are two-to-one, 10-to-one, 50-to-one and 100-to-one. There is no set ... Read Full Answer >>
  5. Why would you undertake a reverse split?

    Most reverse stock splits are undertaken by small, micro penny stocks that need to maintain the minimum price requirements ... Read Full Answer >>
  6. Why would a company perform a reverse stock split?

    A company performs a reverse stock split to increase its share price. The desire to increase the share price is usually driven ... Read Full Answer >>
  7. Are over-the-counter stocks different from other stocks?

    As of 2015, premiere stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq, have stringent listing requirements, ... Read Full Answer >>
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    A stop order, commonly referred to as a stop-loss order, is an order placed with a broker to sell a security when it reaches ... Read Full Answer >>
  9. I own options on a stock, and it's just announced a split. What happens to my options?

    When the underlying stock of your option splits or even begins issuing a stock dividend, the contract undergoes an adjustment ... Read Full Answer >>
  10. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  11. 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 Full Answer >>
  12. What is a split-adjusted share price?

    If a company has undergone stock splits over its lifetime, comparing historical stock prices to those of the present day ... Read Full Answer >>
  13. 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 Full Answer >>
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