Breaking Down a Reverse Split:
A Reverse Stock Split is an action taken by a company to reduce the total number of its shares outstanding. The company divides its current shares by a number such as 10, which would be called a 1-for-10 split. After the split, shareholders would only be holding 1 share of the stock for every 10 that they used to own. At the same time, the value of each share would be multiplied by 10. For example, you own 100 shares of XYZ stock at $10 per share and a 1-for-10 reverse split is announced. After the split, you will own 10 shares at $100 per share. Overall, a reverse stock split does not add any real value to the company and the Market Cap (Shares Outstanding x Price Per Share) does not change – at least theoretically.
In the real world, however, a reverse split can be viewed as a failure and bring about selling pressure. That’s because in most cases the main reason companies partake in such a practice is to meet exchange listing requirements. Exchanges like the NYSE and NASDAQ have minimum price requirements, and in order for downtrending stocks to maintain their listings, they will undergo reverse splits. Therefore, history of reverse splits is a bad sign for a company and comes with an increased probably that they will need to raise money in the near future by way of a Secondary Public Offering, which dilutes value for current shareholders. A stock split is essentially just a tactic for companies to manipulate their stock price. The opposite of a reverse stock split is a Forward Stock Split, which increases the number of shares outstanding and is typically a sign of success for a company.
Related Page: What is a “Short Squeeze”?
