Finance

Reverse Stock Split

Reverse Stock Split

Reverse Stock Split is a type of corporate action that consolidates the number of existing shares into fewer, proportionally more valuable shares. The reduction in the total number of shares outstanding in the open market can be tracked for a number of reasons and often signals a company in need. A reverse stock split divides the total number of shares in existence by a number such as five or ten, which is then classified as 1- for -5 or 1-for-10 reversed split. It is also known as stock consolidation or stock rollback and is the opposite exercise of a stock split in which a stock is split into multiple parts.

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How does it work?

Companies take several actions at the corporate level that impact the capital structure, which depends on market development and situations. One of these is a reverse stock split. Since decreasing the number of shares doesn’t help the company much, they increase the price per share proportionally. The primary reason for reverse stock splits is to increase the per-share price, and the related ratios can range from 1-for-2 to 1-for-100. Reverse stock splits do not affect a corporation’s value, although they are usually a result of its stock having a decreasing value. The company management proposes reverse stock splits, which require shareholder approval through voting rights.

 Reasons for Reverse Stock Split:

  1. Minimum stock price imposed by exchanges: For exchanges, there is a demand to stay on top of the minimum share price. On the exchange,  a corporation would risk being delisted if its share price closed below $1.00 for 30 consecutive trading days. Therefore, a reverse stock split may be utilized by a company to remain listed on exchanges and meet the minimum share price requirement.
  1. “Improve” share price: In the United States, stocks that trade below $5 per share are considered penny stocks. For investors, shares that trade below $5 are generally deemed not investment grade. As a result, a reverse stock split may be used to secure a company’s brand reputation and avoid the stigma of being tagged a penny stock.
  1. Maintaining an acceptable share price after a spinoff: If a corporation wishes to spin out its business, it can reverse its share prices after the spin-off, to maintain its company’s share price.

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Impact on Market Capitalisation:

A reverse stock split does not increase the market capitalization of a company, but the number of shares outstanding decreases, the stock price is adjusted accordingly, and the market capitalization of the company remains unchanged. In other words, shareholder value remains unaffected by a reverse stock split.

Real-world example:

Citigroup (NYSE: C) was one of the financial institutions that survived the 2008 financial crisis, which was one of the hit hardest bank stocks. As a result, the bank’s shares were trading for mere dollars, more than 90% lower than their pre-crisis high. In 2011 the bank decided to do a 1-for-10 reverse stock split. The share prices traded prior to the split were approximately $4.50 per time and approximately ten times higher after the split.

Bottom Line:

Besides the odd success story, reverse splits are rarely a positive sign for a stock. Because reverse stock splits have no fundamental impact on a company, in the long run, it’s more important to look at the financial health of stock to assess whether a reverse split is likely to work.

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Author: Mahek Medh

About the Author: Currently, I am in my second-year bachelor’s program and over the period of time I have realized that I enjoy learning about numbers and money, and I find topics of Finance to very interesting thus this is the domain and space where I wish to etch my long term career.

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