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What is a Reverse Stock Split?

Wednesday, April 15, 2020 11:17 AM | Bobby Raines
What is a Reverse Stock Split?

A reverse stock split is a process that decreases the number of outstanding shares of a company without changing its overall market capitalization.

A reverse split is essentially the opposite of a stock split.

This has the effect of raising the price of the stock, but does not change the value of an investor's position.

For example, if ZYX stock were trading at $50 per share and the company effected a 1 for 2 reverse split (this is called the split ratio), each shareholder would see the number of shares they hold cut in half. So a holder of 100 shares would have 50 shares post split. Meanwhile, the price of the shares would double, so a 100-share position that was worth $5,000 pre-split, would be a 50-share position with the same $5,000 value post-split.

One place where reverse-splits can get tricky is when an investor has a number of shares that doesn't easily divide by the split ratio. For instance, in the example above, if the investor had 101 shares, what would happen to the extra share? This is up to the company. Sometimes, companies pay out cash in lieu of fractional shares, while other times, fractional shares can rounded up or down.

Why do Companies do Reverse Splits?

Most of the time it is because their shares have fallen by a lot and they need to raise the price to maintain the minimum price set by the exchange where they list their shares (typically $1.00).

They may also want to raise the price of the stock to better align with companies they consider to be peers.

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