What is a reverse stock split, how it works & examples

Imagine waking up to find that the number of shares you own in a company has suddenly decreased—but the value of your investment hasn’t changed. This isn’t an error; it’s the result of a reverse stock split. Companies use this strategy to boost their stock price by consolidating shares, often to meet exchange requirements or improve investor perception. But what does this really mean for you as an investor? Is it a sign of trouble, or just a routine corporate move? In this guide, we’ll break down what a reverse stock split is, why companies do it, and how it can impact your investments.

What is a reverse stock split?

When a company decides to consolidate its existing shares into fewer, more valuable shares, this process is called a reverse stock split. Unlike a regular stock split, where shares are divided into multiple lower-priced shares, a reverse split reduces the number of outstanding shares while increasing the share price proportionally.

For example, if a company announces a 1-for-5 reverse stock split, every five existing shares are merged into one new share. If you owned 50 shares before the split, you would now have 10 shares, but each share would be worth five times its previous price.

Why do companies perform a reverse stock split?

Companies typically use reverse stock splits for strategic reasons, such as:

1. Meeting exchange listing requirements

Stock exchanges like the NYSE and Nasdaq have minimum price requirements. If a stock’s price falls below this threshold for an extended period, the company may face delisting. A reverse stock split helps the stock regain compliance by artificially increasing its share price.

2. Improving market perception

A low stock price may create a negative perception, making the stock seem risky or unstable. A reverse split can make the stock appear more attractive to institutional investors and analysts who prefer stocks trading at a higher price.

3. Enhancing liquidity and attracting investors

Some mutual funds and institutional investors have restrictions on purchasing stocks below a certain price. By increasing the stock price, a company may attract more institutional interest and potentially improve liquidity.

How does a reverse stock split work?

A reverse stock split reduces the number of a company’s outstanding shares while increasing the price per share proportionally. However, the total market value of the company—and your overall investment—remains unchanged.

Here’s a step-by-step breakdown of how it works:

1. Company may announce a reverse split ratio

A company’s board of directors may decide on a reverse split ratio, such as 1-for-5, 1-for-10, or even 1-for-20. The ratio may determine how many old shares will be consolidated into a single new share.

2. Share count may be adjusted

If a company executes a 1-for-5 reverse stock split, it may mean that every 5 shares of stock are combined into 1 new share.

• If you owned 100 shares before a 1-for-5 reverse split, you may now own 20 shares.
• If the stock price was $2 per share, the new price may become $10 per share (since 5 shares are now merged into 1).

3. Stock price may adjust proportionally

While the number of shares may decrease, the price per share may increase proportionally to maintain the same market capitalization. So, if a company was worth $500 million before the split, it may still be worth $500 million after the split.

4. Fractional shares may be handled with cash

If the reverse split does not result in a whole number of shares, investors may receive cash in place of fractional shares. For example, if you owned 13 shares in a 1-for-5 reverse split, you may receive 2 new shares and cash for the value of the remaining fraction.

5. Trading may continue under the adjusted price

Once the reverse split takes effect, the stock may begin trading at its new adjusted price on the market. The company’s ticker symbol may temporarily change with a suffix like “D” to indicate the adjustment.

Reverse stock split example

There isn’t a fixed formula for determining the ratio of a reverse stock split, but some of the most common splits may include:

• 1-for-2 (1:2)
• 1-for-10 (1:10)
• 1-for-50 (1:50)
• 1-for-100 (1:100)

The ratio a company chooses may depend on its goal for how much it wants its stock to trade at on the exchange.

Example of a reverse stock split

Suppose XYZ Company announces a 1-for-10 reverse stock split. In this case:

• Shareholders may receive 1 new share for every 10 shares they previously owned.
• If a shareholder owned 1,000 shares, they would now own 100 shares after the split.

Even though the number of outstanding shares may decrease, the company’s overall value may remain the same. The price per share may adjust proportionally to reflect the pre-split value.

Impact on investors

For an investor, the total value of their holdings may not change. Consider this scenario:

• An investor owns 1,000 shares priced at $1 each (total value: $1,000).
• After a 1-for-10 reverse stock split, they would now own 100 shares, but the price per share may rise to $10.
• The total value of their investment may still be $1,000—the same as before the split.

A reverse stock split may not directly affect an investor’s holdings in terms of value but may influence how the stock is perceived in the market.

Benefits of reverse stock splits

When a company considers a reverse stock split, it weighs both the advantages and disadvantages of how the split may impact its business. Some potential benefits include:

1. Preventing removal from the stock exchange

One of the primary reasons a company may conduct a reverse stock split is to maintain its listing on major stock exchanges.

• Stock exchanges like the New York Stock Exchange (NYSE) and Nasdaq have minimum price requirements for listed stocks.
• If a stock trades below the required minimum price for an extended period, it may face delisting, which can negatively impact the company’s reputation and market access.
• By increasing the stock price through a reverse split, the company may prevent delisting and remain publicly traded.

2. Satisfying jurisdictional regulations

Regulatory compliance may depend on the number of shareholders a company has.

• Some regulations require companies to maintain a certain number of shareholders or adjust share distribution to comply with governance rules.
• A reverse stock split may help a company reduce its number of outstanding shares and meet legal or jurisdictional requirements.

3. Optimizing spinoff pricing

When a company decides to spin off a new entity, a reverse stock split may help manage the pricing strategy.

• A company may create a spinoff by selling additional shares of the existing business while introducing a new company.
• The original company (now the parent company) may execute a reverse stock split to make its shares more attractive to investors.
• This strategy may improve market perception and facilitate better pricing for both the parent company and the newly spun-off business.

While a reverse stock split does not change a company’s fundamental value, it may serve as a strategic tool to meet exchange requirements, regulatory standards, and market positioning objectives.

Should investors be concerned about a reverse stock split

A reverse stock split alone isn’t necessarily bad or good—it depends on why the company is doing it. If the company is financially sound and restructuring its shares for strategic reasons, it might not be a red flag. However, if the company has weak fundamentals and a history of stock price declines, the reverse split could be a warning sign.

Before reacting to a reverse stock split, consider:

1. Company’s financial health – Is it performing well, or is the stock struggling?
2. Reason for the split – Is it for compliance or just an attempt to mask poor performance?
3. Long-term growth potential – Does the company have a strong business model?

Conclusion

A reverse stock split may change the structure of a company’s stock by consolidating shares and increasing the price per share. While it does not directly affect the company’s overall value, it may help a company meet exchange requirements, improve investor perception, or manage regulatory obligations.

For investors, a reverse stock split does not immediately impact the total value of holdings but may influence how the stock is perceived in the market. In some cases, it can be a strategic move for financially stable companies, while in others, it may signal underlying financial struggles.

Before reacting to a reverse stock split, it may be useful to evaluate the company’s financial health, long-term growth potential, and the reason behind the split to determine whether it aligns with your investment strategy.