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Reverse Stock Split: Explanation, Pros & Cons

Updated: Jun. 21, 2022By: Kent Thune

A reverse stock split reduces the number of shares of stock that a company has outstanding. The reduction in the amount of shares also increases the price per share.

Reverse Stock Split Market Company Strategy Ticker 3d Illustration
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What Is a Reverse Stock Split?

A reverse stock split occurs when a company converts each share of its outstanding stock into a fraction of a share.

Also known as a stock consolidation, a share rollback, or stock merge, a reverse split has the effect of decreasing the number of shares outstanding and increasing the share price.

Important: Decreasing the number of outstanding shares and increasing the share price does not create value for the company. In many cases, reverse splits come as a result of a decline in share price. Because of this, reverse splits are generally considered to be bad news.

How a Reverse Stock Split Works

The opposite of a stock split, a reverse stock split divides a company's outstanding shares by a number, such as two, five, ten, or as much as 100. A reverse split also causes a proportional increase in the share price. For example, a 1:2 stock split would divide the number of shares in half but would double the share price.

Typical steps in a reverse stock split are:

  1. Company management proposes a reverse stock split to the company's board of directors.
  2. The board of directors votes in favor of the reverse split, which is subject to the approval of shareholders through a vote.
  3. The company publicly announces the split, as well as detailed information, such as the split ratio and the date of the split.
  4. On the split date, the company cancels its current outstanding shares and distributes new shares to existing shareholders in proportion to the amount of shares owned prior to the split.

Tip: For companies that pay dividends, a reverse stock split would adjust any future dividends in proportion to the split. For example, let's say a company had a 1:2 reverse split, and they normally paid $2 per share in dividends before the split. The dividends after the split would now be $4 per share, and the dividend yield would be unchanged.

Reverse Stock Split Example

For a specific example of a reverse stock split, let's say you owned $10,000 in XYZ Company stock. The share price is $10 per share, meaning that you own 1,000 shares. If XYZ Company announced a 1:2 reverse stock split, you'd end up with 500 shares, each worth $20. You would still own $10,000 worth of shares.

Reasons for a Reverse Stock Split

1. To Prevent Being Delisted

A common reason for a reverse split is to prevent the company from being delisted from a stock exchange, such as the NYSE or Nasdaq. This can happen after a significant decline in price. For example, the NYSE can delist a stock if it trades below $1 per share for an extended period of time.

2. To Prevent the Negative Perception of a Low Stock Price

In addition to the potential for delisting from a stock exchange, a low stock price can be associated with negative perception from investors, which can cause further selling. A reverse stock split can help to elevate the image of a company whose stock price has dropped significantly.

3. To Maintain Favor with Investors

Another reason for a reverse stock split is to maintain favor with large investors that can influence price. Some institutional investors have restrictions that disallow investing in delisted stocks or those selling on the OTC market.

Pros & Cons of a Reverse Split

Benefits of a Reverse Stock Split

  • Boost image: The primary purpose of a stock split is to increase the share price, which is often done to gain or maintain favor among influential investors.
  • Prevent stock exchange delisting: A reverse stock split can be done to increase the share price to meet the minimum price requirement of the stock exchange.

Disadvantages of a Reverse Stock Split

  • Loss of liquidity: Since a reverse split reduces the number of shares available in the market, the split can harm liquidity, which can then negatively impact share price.
  • Negative perception: Although a reverse stock split can help to boost a stock's image among investors, reverse splits are often received as a negative sign that the company is struggling.

Bottom Line

A reverse stock split reduces the number of a company's outstanding shares and proportionally increases the share price. While a higher share price can help to boost a company's image, reverse splits are generally received by investors as a potential sign of fundamental weakness.

This article was written by

Kent Thune profile picture
923 Followers
Kent Thune, CFP®, is a fiduciary investment advisor specializing in tactical asset allocation and portfolio management with a focus on ETFs and sector investing. Mr. Thune has 25 years of wealth management experience and has navigated clients through four bear markets and some of the most challenging economic environments in history. As a writer, Kent's articles have been seen on multiple investing and finance websites, including Seeking Alpha, Kiplinger, MarketWatch, The Motley Fool, Yahoo Finance, and The Balance. Mr. Thune's registered investment advisory firm is headquartered in Hilton Head Island, SC where he serves clients all around the United States. When not writing or advising clients, Kent spends time with his wife and two sons, plays guitar, or works on his philosophy book that he plans to publish in 2024.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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