What is a Reverse Split?

Published by Thomas Herold in Investments, Trading

'Reverse Split' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A reverse split is also known as a reverse stock split. Reverse splits are used to reduce the total outstanding number of a given company’s shares. This action boosts the value of its stock and the resulting earnings per share. Not everything concerning a stock changes in a reverse stock split. One thing that remains the same is the market capitalization. Market capitalization refers to the value price of the total outstanding number of shares.

A reverse split works by a certain process. In this scenario, a company involved will actually cancel out the presently existing shares for every share holder. They will replace these with a smaller number of new shares. These new shares will be issued in an exact proportion to your original stake in the company.

Such a reverse split proves to be the exact opposite of a stock split. Reverse splits can also be called stock merges, since they literally reduce the total number of outstanding shares and proportionally increase the price per share. Companies commonly issue the reverse split shares according to an easy to understand ratio. You might receive one new share for every two old shares, or possibly four new shares for every old five ones that you owned.

Looking at an example of the way that a reverse stock split actually works is helpful. Say that a company in which you own stock shares decided to affect a one for ten reverse split. If you had one thousand shares of the company, then you would only own one hundred shares of the resulting issue. This would not change the value of the shares that you held though, as the price of the shares would increase by ten times. If the shares had been worth only four dollars per share, now they would be valued at forty dollars per share.

There are several reasons why companies choose to do a reverse split of their stock shares. They might feel that the actual price per share of their stock is so low that it is not appealing to new investors. Some institutions are only allowed to buy shares that trade at a certain minimum value, such as five dollars per share or higher. Reverse stock splits can also be used to reduce the number of share holders, since they can force smaller shareholders to be cashed out, which means that they no longer possess any shares of the company. In this case, you would receive the value of your shares in cash.

There is a negative connotation associated with engaging in reverse stock splits. Because of this reason, they are not done lightly by companies. A company might find that its share price has declined so precipitously that it becomes in danger of having its shares de-listed from the stock exchange. They could quickly boost the share price with the reverse split. Stocks that have undergone a reverse split will usually have the letter D added to the end of their symbol tickers.

A board of directors for a given company is allowed to perform a reverse split without consulting with its share holders to obtain their approval. The Securities and Exchange Commission also does not have any say over such reverse stock splits. They are instead regulated by a state’s corporate laws and the company’s own articles of incorporation, along with the company’s by laws.

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The term 'Reverse Split' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.