High stock prices aren't the be-all-end-all, but sometimes public companies want to increase the cost of their share price. A reverse stock split makes a stock look more expensive (even though the equity is the same). Plus, the move can even keep the security trading on a major exchange.
Here's what reverse stock splits mean and whether or not it's a red flag for an investment.
Reverse stock splits, defined
A reverse stock split occurs when a public company decreases its total number of outstanding (sold) shares and decreases the price per stock at the same rate.
Each investor's position keeps the same overall value, but the number of shares in the position decreases while the stock's price increases.
This corporate action generally requires shareholder approval.
Reverse stock split ratios: What they mean
Reverse stock split ratios help investors understand the proportion the stock is changing at. For example, a 1-to-4 (or 1:4) reverse stock split means that a person with 4 shares now has 1, and each of those shares are now worth 4 times the previous value.
In a 1-to-3 reverse stock split, a person with 3 shares now has 1 share. Subsequently, each of those shares is now worth 3 times the previous value.
Why reverse stock splits happen
Companies perform reverse stock splits to increase the price of low-value stocks (including penny stocks). There are a couple of reasons for this:
The company wants to increase the perception of value for a low-priced stock to attract investors interested in premium offerings.
The company wants to stay on a major exchange. Whereas the UAE has the Dubai Financial Market, the US has the NYSE. The NYSE has a minimum stock price of $1 and gives warnings to companies who don't meet the threshold before delisting them.
If a company is desperate, it may perform a reverse stock split to generate buzz from analysts.
Are reverse stock splits bad news?
Reverse stock splits aren't like regular stock splits.
A normal stock split decreases the price of a high-valued stock and increases the number of outstanding shares. This can often be a good sign for prominent companies.
On the other hand, reverse stock splits are often a red flag. If a company gets delisted, you have to sell your investments in the OTC (over-the-counter) market, which is usually more volatile than the regular stock market. A company can perform a reverse stock split more than once, which would be an even bigger red flag.
As with any investment, considering the circ*mstances around the stock and overall market play a factor in your decision to buy or sell.
Examples of reverse stock splits aren't as common as cases of normal stock splits. This is because companies performing reverse stock splits tend to be smaller and less well-known. One example is Nxt-ID Inc. (NASDAQ:NXTD), which just performed a reverse stock split at a 1-to-10 ratio for Series C preferred stock.
FAQs
Reverse stock splits do not impact a corporation's value, although they usually result from 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.
Do companies succeed after a reverse split? ›
Just remember, most companies that execute reverse stock splits falter, and many don't survive. This is speculative investing, so make sure you do your homework. Nancy Zambell has spent 30 years educating and helping individual investors navigate the minefields of the financial industry.
What happens to investors in a reverse stock split? ›
For example, if a stock is trading at 50 cents on the market, and the company declares a two-for-one reverse stock split, then an investor who owned 100 shares worth 50 cents would own 50 shares worth $1 each.
Is it better to sell before or after a reverse stock split? ›
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.
Can you make money from a reverse stock split? ›
Can you make money from reverse stock splits? A reverse stock split isn't usually a get-rich-quick ploy, but it could lead to greater rewards for savvy investors. In some cases, reverse splits can increase investor confidence and potentially boost the price of a stock as more investors take interest and snap up shares.
Should I buy before or after a stock split? ›
The case for buying before the split
A stock split doesn't change anything fundamental about a company or its stock. Though the per-share price will be lower, the maneuver doesn't impact valuation in any real way. That means that post-split, the stock actually could be more expensive than it was beforehand.
Do stock prices go up after a reverse split? ›
Remember that a stock split—or a reverse stock split—does nothing to change the value of a company.
What happens in a reverse stock split if you don't have enough shares? ›
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.
Do most stocks go up after a split? ›
From time to time, stock splits are followed by a bump in stock performance—but not always. Is the split worth it? – Stock splits have no tangible impact on a company's total value—they simply create more shares at more affordable prices.
Does the investor lose money after a stock split? ›
In a stock split, a company divides its existing stock into multiple shares to boost liquidity. Companies may also do stock splits to make share prices more attractive. For shareholders, the total dollar value of their investment remains the same because the split doesn't add real value.
Reverse stock splits appear to convey negative information to the market on average. Daily short selling activity is unusually high after reverse stock splits, but not before. Evidence that short sellers are not more informed about future negative returns around reverse stock splits.
Why did AMC reverse split? ›
The theater chain operator said the money was needed in part to make up for a weaker first-quarter box office because of last year's strikes by Hollywood writers and actors. Last year, AMC held two other stock sales and a reverse stock split in order to raise cash.
What are the disadvantages of a reverse stock split? ›
This type of stock split is often done to increase share prices. While a reverse stock split can improve a stock's price in the near term, it could be a sign that a company is struggling financially. Large fluctuations in stock pricing associated with a reverse stock split could also cause investors to lose money.
Is a reverse stock split ever good? ›
Are reverse stock splits good or bad? All things equal, a reverse stock split is neither good nor bad and has no impact on the value of the total company. However, it often carries a negative connotation as many of the companies doing them are countering a sharp drop in their share price.
How do you take advantage of a reverse stock split? ›
If you own 50 shares of a company valued at $10 per share, your investment is worth $500. In a 1-for-5 reverse stock split, you would instead own 10 shares (divide the number of your shares by five) and the share price would increase to $50 per share (multiply the share price by five).
Is a reverse split bad for options? ›
Reverse stock split
A reverse split results in the reduction of outstanding shares and an increase in the price of the underlying security. The holder of an option contract will have the same number of contracts with an increase in strike price based on the reverse split value.
Do stocks usually go up after a split? ›
“Historically, stocks have notched 25% total returns in the 12 months after a split is announced, compared to 12% for the broad index,” according to the BofA Global Research's research investment committee.
Is a reverse stock split a routine matter? ›
If your shares are held in street name and you do not provide voting instructions to the bank, broker or other nominee that holds your shares, the Company expects that the Reverse Split Proposal and the Adjournment Proposal will each be treated as a non-routine matter, which means that your broker or other nominee will ...
