What is a Reverse Stock Split? (2024)

FAQs

Is reverse split good for a stock? ›

Reverse stock splits do not impact a corporation's value, although they usually are a result of its stock having shed substantial value. The negative connotation associated with such an act is often self-defeating as the stock is subject to renewed selling pressure.

When a reverse stock split is executed, a company cancels its current outstanding stock and distributes new shares to its shareholders in proportion to the number of shares they owned before the reverse split.

Does it matter to buy before or after a stock split? If you buy a stock before it splits, you'll pay more per share than what it'll cost after it splits. If you're looking to buy into a stock at a cheaper price, you may want to wait until after the stock split.

For example, if a company decided on a 1-for-50 reverse split, any holders of fewer than 50 shares wouldn't be offered a fractional new share. They would instead be paid cash for their shares.

Selling before a reverse stock split is a good idea, but selling after the reverse stock split is not. Since you can sell before and after a reverse stock split, selling during one is optional. The main advantage of selling before the reverse stock split is that you don't have to wait around for it to happen.

Often, companies that use reverse stock splits are in distress. But if a company times the reverse stock split along with significant changes that improve operations, projected earnings and other information important to investors, the higher price may stick and could rise further.

A company may declare a reverse stock split in an effort to increase the trading price of its shares – for example, when it believes the trading price is too low to attract investors to purchase shares, or in an attempt to regain compliance with minimum bid price requirements of an exchange on which its shares trade.

For example, if most shareholders of a stock own fewer than 1,000 shares, the company can do a 1:1,000 reverse split and squeeze out the investors who own fewer shares by paying them for their holdings. Those shareholders would either have to accept that price or buy more shares to total 1,000.

A stock split doesn't make investors rich. In fact, the company's market capitalization, equal to shares outstanding multiplied by the price per share, isn't affected by a stock split. If the number of shares increases, the share price will decrease by a proportional amount.

If you own 1,000 shares -- worth $1,000 at current prices -- you'll get one new share for every 10 old shares you own, or 100 new shares. Immediately after the reverse split, the stock price will rise tenfold to $10 per share.

Why is a share of Berkshire Hathaway over $300,000? ›

How did the Berkshire Hathaway Class A shares become so expensive? It was a deliberate strategy by Warren Buffett to keep the number of shareholders low. When most companies increase in value, the corporation will “split” shares - give you two shares for each one you have, cutting the price in half.

A stock split does not change the value of a stock because it does not change the fundamentals or growth prospects of the underlying company.

Disadvantages of a Stock Split

A company cannot rely on a stock split to increase its value or market cap. A stock split divides the existing shares, thus keeping the market cap the same as before. Not to forget, a company must invest some amount to conduct a stock split.

A reverse stock split may be used to reduce the number of shareholders. If a company completes a reverse split in which 1 new share is issued for every 100 old shares, any investor holding fewer than 100 shares would simply receive a cash payment.

Several of these studies allude to the notion that reverse stock splits might attract short selling activity. Kadiyala and Vetsuypens (2002) suggest that if reverse stock splits enhance liquidity, as documented in Han (1995), both the risk of a short squeeze and the opportunity cost of a short sale are lowered.

On the flipside, a reverse split is done to reduce the number of outstanding shares and thus increase the price of a stock that has fallen and is perhaps at risk of being delisted. This move is typically seen as bearish for the company, and the stock often moves lower as a result.