Understanding reverse stock split for investors

In reverse stock split, total numbers of outstanding shares are reduced to a lower number and the share price is proportionately increased to compensate the shareholders.

This process takes multiple shares from investors and replaces them with a smaller number of shares in return.

reverse-stock-split

Reverse stock split does not add any real value to the company and investors. It’s also known as consolidation or share rollback.

For instance, if you own 100 shares of XYZ Company at Rs. 50 per share on a particular date and due to some economic turmoil, company share price has been reduced to Rs. 0.5 per share, then to avoid liquidity problem and delisting, management may decided to go for reverse split of 10 : 1 i.e. one for 10 shares.

This decision of reverse split will give you 10 shares of XYZ Company @ Rs.5 each by decreasing the total number of outstanding shares and simultaneously increasing the price per share from 0.5 to 5.

Reverse stock split will neither increase nor decrease the net financial impact in the hands of investors. It’s the opposite of a stock split, which increases the number of outstanding shares and decreases the price per share.

Table showing reverse stock split examples

Pre Split After Reverse Split
Ratio 1 for 10
Number of shares 10,000 1,000
Market price 0.5 5
Value of shares 5,000 5,000
Ratio 1 for 20
Number of shares 10,000 500
Market price 0.5 10
Value of shares 5,000 5,000

Why reverse stock split

Reverse stock split is a corporate decision taken based on so many factors. Below we have listed two important factors in which company’s management may take a decision to go for reverse split;

  • Different exchanges have different rules and regulation. If a particular share is traded below a particular limit for a long time then there are chances that the particular share gets delisted.  To avoid such delisting, board of directors may decide to go for reverse stock split.
  • Investors are not interested in investing as shares of the company are trading in the penny stock range.