What Is a Reverse Stock Split and How It Affects Your Investments

A reverse stock split is a corporate action that can significantly impact your investments. It's a move made by a company to reduce the number of outstanding shares by consolidating them into a smaller number of shares with a higher par value.

This can be a complex and confusing process for investors, but it's essential to understand how it affects your portfolio.

A reverse stock split is often done to maintain the company's listing on a major stock exchange, such as the New York Stock Exchange (NYSE) or NASDAQ.

Consider reading: Outstanding Common Stock Refers to the Total Number of Shares

A reverse stock split is a reduction in the number of a company's outstanding shares in the market, typically based on a predetermined ratio.

It's the opposite of a stock split, where a company divides its shares among investors, increasing the total number of shares.

A 2:1 reverse stock split means an investor would receive 1 share for every 2 shares they currently own, effectively reducing the number of shares.

The company's market capitalization and the total value of your shares don't change, but the number of shares you own and their value do.

If you own 50 shares of a company valued at $10 per share, your investment is worth $500.

Discover more: Issuing New Shares of Common Stock Will

Companies undergo reverse stock splits when their share price falls too low, putting it at risk for delisting from an exchange for not meeting certain minimum price requirements.

A reverse stock split is usually done to raise the share price enough to continue trading on the exchange, such as the New York Stock Exchange, where a stock that closes below $1 for 30 consecutive days could be delisted.

Having a higher share price can also attract certain investors who would not consider penny stocks for their portfolios.

If a company's share price is too low, investors may steer clear of the stock out of fear that it's a bad buy, giving the perception that the low price reflects a struggling or unproven company.

To fight this problem, a company may use a reverse stock split to increase its share price.

A company may use a reverse stock split to attract big investors, as many institutional investors and mutual funds have policies against taking positions in a stock whose price is below a minimum value.

By reducing the number of shares, companies can also satisfy regulators in different jurisdictions around the globe, depending on the number of shareholders.

Companies planning to create and float a spinoff may also use reverse splits to gain attractive prices for their spinoff company shares.

For another approach, see: What Nvidia Stock Split Means for Investors

A reverse stock split can have a significant impact on a company's market capitalization. However, it's essential to understand that market capitalization remains unchanged after a reverse stock split.

The number of shares outstanding decreases, but the stock price is adjusted accordingly to maintain the pre-reverse stock split market capitalization. This means that shareholder value is unaffected by a reverse stock split.

Here's an example to illustrate this concept:

As you can see, the market capitalization remains the same, even though the number of shares outstanding has decreased.

A reverse stock split is generally not viewed positively by the market, indicating that a company is in distress and its stock price is sinking.

The market often perceives a reverse split as a sign that a company's management is attempting to inflate prices artificially without creating any shareholder value.

It signals that a company's share price has declined significantly, possibly putting it at risk of being delisted.

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The higher-priced shares following a reverse split may be less attractive to certain retail investors who prefer stocks with lower sticker prices.

The number of shares is reduced in the open market, leading to higher bid-ask spreads and higher transaction costs for investors.

This can make it more difficult for investors to buy and sell shares, which can further impact the stock's liquidity.

For your interest: How Are Stock Speculators Different from Stock Investors

A reverse stock split can have a significant impact on a company's share price. The market often views reverse splits negatively, as they signal that a company's share price has declined significantly.

The announcement of a reverse stock split often sends out a negative signal to the market. In theory, the impact of reverse splits on a company's valuation should be neutral, but in reality, investors can view reverse splits as a "sell" signal, causing the share price to decline even further.

The post-reverse split share price is calculated by multiplying the pre-split share price by the number of shares consolidated into one share. For example, if the pre-split share price was $0.90, the post-reverse split share price would be $9.00 (as calculated in Example 6).

Additional reading: What Is Bid Price in Share Market

The market reaction to the split determines whether there truly is no value lost over the long run. As noted in Example 5, the concern with reverse stock splits is that they tend to be perceived negatively by the market.

A reverse stock split may be used to protect a company's brand image and prevent the negative stigmatization of being labeled a penny stock, which typically trades at less than $5 per share.

The following table outlines the most common reverse split ratios and how to compute the post-split shares owned by the investor and the split-adjusted share price:

Note: The table is based on the formulas provided in Example 8.

If you own shares that undergo a reverse stock split, the number of shares you own will be reduced, but the total value of your holdings remains the same.

The price of each share will increase proportionally, so if you owned 10,000 shares before the split, your shares would be consolidated into 1,000 shares afterward, and each share now has a higher price. For example, if the shares were trading at $0.50 each before the split, the new price per share would likely be around $5.00 after the reverse stock split.

A reverse split will not affect your taxes, and your broker will handle the consolidation of your shares automatically.

Here are some examples of how reverse stock splits can affect share ownership:

The market value of your equity remains the same, so if your shares were worth $180.00 before the split, they would still be worth $180.00 after the split, even if the number of shares you own is reduced.

A reverse stock split is a corporate action that can have a significant impact on a company's stock price and share count. In 2002, AT&T Inc. (T) performed a 1-for-5 reverse stock split to avoid a significant decline in its share price after spinning off its cable TV division.

This action reduced the total number of outstanding shares from 10 million to 2 million, increasing the stock price from $5 to $25 per share. Despite the higher share price, the company's overall value remained the same.

Barnes & Noble Education completed a 1-for-100 reverse stock split in 2024, reducing the total number of outstanding shares from approximately 2.62 billion to around 26.2 million. This action raised the stock price from $2 to $20 per share.

However, shares then fell sharply, highlighting the potential risks of reverse stock splits. General Electric's (GE) stock price had been struggling for years, and the company decided to implement a 1-for-8 reverse stock split in June 2021.

Take a look at this: What Happens When a Stock Splits 3 to 1

A reverse stock split doesn't change the overall value of your investment. The smaller number of post-split shares is offset by the proportionally higher per-share price.

As an investor, you should evaluate the situation and determine if a reverse split makes sense for you to hold. If a company announces a reverse split, read the press release and SEC filings to decide if it was a smart business decision or a desperate maneuver.

A reverse split can be a sign of trouble, but it's not always bad. In rare cases, it can give a company the time it needs to get back on track.

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Splits can be viewed negatively by the market, as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted.

A reverse split isn't necessarily good or bad by itself, it's simply a change in the stock structure of a business that doesn't change anything related to the business itself.

The market often views reverse splits as a sign of trouble, and most of the time it isn't done for a positive reason. In rare cases, a reverse split can buy a company the time it needs to get back on track.

Priceline, now Booking Holdings, did a 1-for-6 reverse split following the internet tech bust and since bottomed in late 2000, shares of the travel company are up more than 6,000%.

The value of an investor's position in a stock doesn't change because of a reverse split, the smaller number of post-split shares is offset by the proportionally higher per-share price.

A fresh viewpoint: Market Price per Share of Common Stock

When evaluating whether to sell, it's essential to consider your individual goals and risk tolerance. Every investor is different, and there's no one-size-fits-all answer.

The decision to sell should be based on a thorough evaluation of the situation. Long-term investors might view a reverse stock split as a necessary step in a company's restructuring plans, but others might see it as a sign of future market volatility.

Ultimately, the decision to sell or hold depends on your personal expectations and risk tolerance. There's no perfect answer, and what works for one investor might not work for another.

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