A reverse stock split occurs when a company merges or consolidates shares into fewer, more expensive ones. Other names for this are stock consolidation, share rollback, and merger. In contrast, a forward stock split creates many lower-priced shares. Reverse stock splits, their causes, and investor information are covered here.
A reverse stock split is an announcement by a corporation that it intends to combine its shares into fewer, more valuable ones. If a firm announces a 1-for-5 reverse split, for example, it means that for every five shares you presently possess, you will now own one share, or the cumulative value of all your shares will be the same.
For example, let’s pretend that you’re the proud owner of five $5 shares in firm XYZ. After the 1:5 reverse split, one share of XYZ would be valued at $25.
Since the company just combined the initial five shares into one, the value of your shareholding remains unchanged. A company’s desired trading price is a major factor in determining the reverse split ratio, which might vary. For example, a common reverse swap ratio could be 1:100, 1:50, 1:10, or 1:2.
These are the Most Popular Reverse Stock Split Questions
If a reverse stock split occurs, what becomes of the remaining shares? This is a typical concern among investors, particularly when their present share holdings do not allow for a perfect swap ratio. Take Company ABC for example; it recently announced a 1:2 reverse split, and you happen to own 25 shares. Are you going to end up with 12.5 shares?
In the event of a reverse split, the corporation typically avoids fractional shares by doing one of two things. In rare cases, they may round up an investor’s fractional share number to the next whole number; in this case, it would be 13, rather than 25.
In most cases, they will simply pay out any remaining fractions of shares in cash. If this were to happen, you would have 12 shares after the split and receive payment for half of them.
The impact of a reverse stock split on dividend payments is another frequent topic of inquiry. The reverse split ratio consolidates dividends in the same way that the share value does. Therefore, with a 1:5 split, a single share would pay out a $1.25 dividend instead of the previous $.25 dividend per share.
Why do backwards stock splits occur?
The public views a reverse stock split in a negative light, in contrast to a forward stock split, because it indicates that the company is not performing well. So, what makes a business think about it at all? A company may do this for several reasons, including:
In order to prevent delisting,
Major exchanges like the NASDAQ and the NYSE require businesses to meet specific criteria for listing. If a corporation fails to meet these conditions after a specific amount of time, it faces the risk of “delisting” from the exchange. Companies that have difficulty meeting these standards may find the push they need to stay listed through a reverse stock split.
To maintain the company’s credibility,
Trading in or around the penny stock zone can indicate that the company isn’t at imminent risk of delisting. Large institutional investors typically stay away from penny stocks, which are equities that are currently trading for less than $5. Institutional backing is typically an essential part of significant price movement, which is adverse news for the company. Some have speculated that the corporation is trying to pique the interest of analysts and big market players with a reverse split.
A Financial Prognosis in Peril
A reverse stock split might help cushion the blow of an unfavorable earnings report that may come from a struggling company’s finances. Increasing a share’s price gives the stock more wiggle room before it falls into the penny stock or delisting zone.
For each reason, a reverse stock split has pros and cons. A successful outcome could be that the business maintains its listing on a significant market or that its share price remains above the fatigue of institutional investors. However, many experts believe it is unhelpful because the company’s actions are usually transparent. In these situations, reversal splits may worry owners and deter investors.
There are stronger arguments in favor of reverse stock splits
In some cases, a reverse stock split might really be beneficial for the company. Therefore, it’s not always an unfavorable event. This is an example of a scenario in which a reverse stock split would be appropriate.
Acquisitions and mergers
Merging the shares of the acquired firm with one’s own is a frequent practice for companies that buy or merge with other businesses. However, if the number of shares exceeds what the company’s articles of incorporation allow, an issue may arise. If this were to happen, the acquiring business could easily combine the acquired company’s shares with their own by doing a reverse stock split. After the purchase, the target firm’s shareholders would exchange their old shares for new, equal-valued shares in the purchasing corporation.
Diminutive Float for Huge Investors
A reverse split can significantly lower a company’s total number of shares available for purchase. If an investor wants to buy a big stake in the company but can only afford a modest number of shares, this can be a beneficial option for them. For huge institutional investors, who often purchase shares in bulk, a reverse split also reduces transaction costs. A decrease in the number of shares in circulation leads to an increase in earnings per share (EPS), which can boost a share’s price.
There are a number of reasons why a firm might conduct a reverse stock split; as an investor, you should be aware of these reasons. The company’s explanation can infer whether the reverse split is a cause for concern or could truly benefit shareholders.
