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A reverse stock split occurs when a publicly traded company reduces the number of shares outstanding. A reverse stock split reduces the number of shares outstanding and proportionately increases the price per share of those outstanding shares. This process differs from a forward stock split, where the number of shares increases and the stock price decreases after the split.
Reverse Stock Split: What It Means
In a traditional forward stock split, a company increases the number of shares outstanding and decreases the price per share by the same proportion. For example, a 2:1 stock split increases the number of shares twice while dividing the stock price by two.
A reverse stock split essentially reverses that calculation. In a reverse stock split, a company reduces the number of shares outstanding, causing the stock price to increase. For example, in a 1:3 stock split, the number of shares is divided by three, while the stock price is multiplied by three times.
In either case, the company’s total market capitalization – the total value of all its shares – remains the same.
A recent example of a reverse stock split occurred at General Electric, which completed a 1:8 stock split in July 2023. This corporate action increased the stock price by eight times on the effective date of the reverse split and reduced the number of shares outstanding by dividing the pre-split total by eight.
Why do companies do reverse stock splits?
A company may conduct a reverse stock split for several reasons.
Avoid being deleted
If a company’s stock price falls too low, a stock exchange can delist its shares. A stock exchange listing is important to ensure public confidence in a company, maintain investor interest and attract capital. A reverse split can be a quick way to push the stock price above the exchange’s required level for continued listing.
Increase the stock price to improve investors’ perception of the company
If a company’s stock price falls into the single digits per share or lower, investors may view the stock as a penny stock and become skeptical about its business prospects. A low share price can also push the stock out of market for some investors, especially institutional investors, which may be required by their charter to avoid stocks with a low price per share.
Keep the stock within a normal trading range
A reverse split can also return a stock to a normal trading range, which can range from $20 per share to $120 per share or thereabouts. If a stock’s share price falls too far, it may fall off the radar of influential stock analysts and institutional investors.
Are reverse stock splits good or bad?
All things being equal, a reverse stock split is neither good nor bad and has no impact on the value of the overall company. However, it often has a negative connotation, as many of the companies that do this experience a sharp decline in their share price. Some investors may view a reverse split as a way to increase the stock price without actually improving fundamentals.
“It’s usually a very negative sign when a company reverse splits its stock,” says Charles Kaplan, president of the investment advisory firm Equity Analytics. He indicated that the market reaction often depends on other steps the company can take to reverse the situation that led to the lower share price.
What Happens to Your Stocks After a Reverse Stock Split?
The total value of the shares – the company’s market capitalization – will be the same after the reverse split as it was before the split. The slight exception to this would be if the company decided to cash out any fractional shares that would result from the reverse split.
If your shares are held by an online stock broker or other type of custodian, the transaction will be seamless and handled electronically.
Normally, there are no tax consequences as a result of a reverse stock split. One exception is a reverse split where cash payments were made to shareholders in lieu of fractional shares. These distributions may be subject to capital gains taxes depending on the shareholder’s cost basis and holding period. This wouldn’t be a problem if the shares were held in a tax-advantaged retirement account such as an IRA.
Whether a reverse stock split will ultimately be positive or negative for shareholders will depend on the situation surrounding the specific company. Investors should view each reverse stock split based on the unique issues and fundamental characteristics of the individual company and its stock.
In short
Reverse stock splits can be a solution for companies facing delisting or struggling with a low stock price. While they may have negative connotations, their impact on shareholders ultimately depends on the specific circumstances of the company. As investors, it is important to carefully evaluate the reasons behind a reverse stock split and consider the long-term potential of the company.
