A reverse stock split is a decrease in the number of shares of stock outstanding without any change in shareholder’s equity or market value for the company at the time of the split. As outstanding shares decrease, each share’s value increases proportionately, so there is no effect on the company’s total net value with a reverse stock split.
Reverse stock splits are one of many corporate actions a company’s board of directors use to facilitate key capital structure initiatives. But, are reverse stock splits good or bad for investors?
Reverse split example
A one-for-ten reverse stock split gives every shareholder one share for every ten shares owned while increasing the value of each share by a multiple of ten.
So, if you have 10 shares of stock worth $5 per share, the total market value is $50. If the company announces a one-for-ten reverse stock split, you would now have 1 share of stock worth $50.
For example, a one-for-ten reverse stock split would reduce the number of shares outstanding and give every shareholder one share for every ten shares owned, while increasing the value of each share by a multiple of ten.
Consider a shareholder with 10 shares of XYZ stock at $5 per share for a total market value of $50. If company XYZ announces a one-for-ten reverse stock split, the shareholder would now have 1 share of XYZ stock worth $50.
If a company announces a reverse stock split and a shareholder does not have a round number of shares to convert, the shareholder will receive the greatest number of whole shares that can be converted and the remainder in cash.
For example, if a company announces a one-for-three reverse stock split and the investor holds 17 shares, they would receive five shares of the underlying and the equivalent of .66 shares in cash. With the rise of fractional shares, some companies may just give investors the full amount in stock (5.66 shares in this example).
Reverse splits can be one-for-two, one-for-four, one-for-ten, or any proportion the board of directors chooses. Companies often use a reverse stock split after a significant decline in stock price because the reverse split increases the price per share of the company’s stock, making the stock appear more attractive to potential investors.
Is a reverse stock split good or bad?
Companies often use a reverse stock split after a significant decline in stock price because reverse splits increase the price per share of the company’s stock, making the stock appear more attractive to potential investors.
A reverse stock split is neither good nor bad for the investor, as there is no impact on the company’s total market value.
However, companies often use reverse stock splits to increase a stock’s marketability because many institutional investors cannot purchase shares that trade for less than $5 or less than $10 per share.
Do you lose money on a reverse split?
No. You do not lose money or make money with a reverse stock split.
You simply have fewer shares of stock, but each share will have more value.
How do you profit from a reverse stock split?
Reverse stock splits (and stock splits) do not increase or decrease the company’s value or the shares of stock outstanding, so there is no opportunity to profit solely from the act of the reverse split.
At first glance, it may appear like you’ve made money because the stock price is higher. But remember, your share number decreases proportionally, so your total investment remains the same, and you still control the same amount of equity.
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