What are Reverse Stock Splits?

When 30-year-old Rohan casually checked his stock portfolio one fine morning, something caught his attention. A company in which he had recently invested showed fewer shares. However, the total value was the same. At first, Rohan thought it was a technical glitch and panicked. However, just a little later, he received a company update regarding reverse stock splits and understood everything was fine. So, what is a reverse stock split and its various aspects? Let us find out.

Reverse Stock Split Meaning

A reverse stock split, also known as stock consolidation, is the opposite of a stock split. In reverse stock splits, companies reduce the total number of outstanding shares in the market. However, it increases the share price proportionately to ensure that investors’ stock value and the company’s market capitalisation remain unchanged.

Reverse Stock Split Example

Let us understand reverse stock splits with an example. Suppose you own 100 shares of XYZ company, each priced at ₹10. Your total investment value is ₹1000 (100 X 10). The company has 1,00,000 outstanding shares in the market. It announces a 100:1 reverse stock split. It means every 100 shares will now be converted into 1 share. So, now you have just a single share of the company.

The company's market capitalisation before the reverse stock split would be ₹10 lakh (1,00,000X10). The shares outstanding after the split would be 1000 (1,00,000 /100). To keep the market cap the same, the share price would be proportionately increased to ₹1000 per share.

Therefore, your investment value, which stood at ₹1000 before the split, remains the same after the split, i.e., ₹1000.

Why Do Companies Opt For Reverse Stock Splits?

Now, why do companies go for reverse stock splits? The reasons are plenty. Some of them are:

• Fulfilling Exchange Requirements

Stock exchanges mandate a minimum price requirement for shares to remain listed. If prices fall below, the chances of delisting loom large. A reverse stock split increases the likelihood of a share price increase and can prevent a company from being delisted.

• Improve Investors’ Perception

How would you feel if the shares of the company you have invested in kept falling? Definitely not good. When it happens, investors often believe the firm is struggling. It may not be fully true. A reverse stock split increases the share price and improves investors’ perception of the company. A ₹5 share becoming ₹50 after a 10:1 reverse split can create a more positive perception.

• Strategic Business Plan

Companies may carry out reverse stock splits as a part of their strategic business plans. Firms may do it before undergoing mergers or fundraising. Fewer shares with higher prices may help the company look financially stronger during such events.

What To Do After A Reverse Stock Split?

As said, a reverse stock split keeps your investment value the same. However, there are certain things you need to keep in mind after a reverse stock split. These include:

• Keep an Eye on the Share Price

A reverse stock split can create short-term market volatility. Keep an eye on how the market reacts to the split. Doing so can help you understand sentiment. It can help you identify potential buying and selling opportunities.

• Stay Informed

Keep an eye on the company’s news and information post-reverse stock split. Keep a tab on their financial performance and future plans that might affect the stock’s performance.

Conclusion

Companies resort to a reverse stock split to address specific situations. While it reduces the number of shares you hold, it does not materially change your investment value. However, as an investor, it is vital for you to keep a close tab on news posts about reverse stock splits for informed decision-making.

Sources:

Investopedia
Corporate Finance Institute