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?   

What is a reverse stock split? 

A reverse stock split decreases a company’s number of shares without changing shareholder’s equity or market value at the time of the split. 

Each share’s value increases proportionately as the number of shares decreases, so there is no effect on the company’s or investor’s total market value with a reverse stock split.

Sound complicated? It’s not. The important thing to remember is reverse splits have no impact on the value of your investment, even though the share price increases. Here’s an easy example.

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.

If a company announces a reverse stock split and a shareholder does not have a round number of shares to convert. In that case, the shareholder will receive the greatest number of whole shares that can be converted and the remainder in cash.

Suppose a company announces a one-for-three reverse stock split, and you own 17 shares. You 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-five, one-for-twenty, or any proportion the board of directors chooses. 

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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