Reverse Stock Split

A reverse stock split reduces a company's outstanding shares based on a set ratio, unlike a regular stock split which increases the number of shares.
OPEN ACCOUNT
What is a Reverse Stock Split
OPEN ACCOUNT
3 mins read
24-April -2024

A reverse stock split is the opposite of a stock split. It involves reducing the number of a company's outstanding shares on the market. This is typically done according to a specific ratio. For instance, a 2:1 reverse stock split would mean that an investor would receive one share for every two shares they currently own.

Think of it as the opposite of a traditional stock split. Instead of dividing shares into smaller pieces, a reverse stock split consolidates them. If you are confused, continue reading as we explain what a reverse stock split does, why companies use it, and how it affects you as an investor.

What is a Reverse Stock Split

A reverse stock split, also known as a stock consolidation, is a corporate action that reduces the total number of a company's outstanding shares, while increasing the share price proportionally. In simpler terms, it's the opposite of a regular stock split, where more shares are issued to reduce the share price.

During a reverse stock split, multiple shares of a company are merged into a single share or a smaller number of shares. This is typically done according to a specific ratio, such as 1-for-5 or 1-for-10. This means that for every 5 or 10 shares an investor owns before the split, they will receive one share after the split.

Pro tip

Invest in equities, F&O, and upcoming IPOs effortlessly by opening a Demat account online. Enjoy a free subscription for the first year with Bajaj Broking.

demat

What does a reverse stock split mean to an investor?

Imagine you own 100 shares of a company, and each share is priced at Rs. 1. That means your total holding is worth 100. Now, let us say the company decides on a 2-for-1 reverse stock split. Here's what happens:

  • Your 100 shares get consolidated.
  • You will end up with 50 shares instead.
  • But, each of those 50 shares will now be priced at Rs. 2.

Essentially, the total value of your holding (Rs. 100) remains the same. The reverse share split just shuffles things around, reducing the number of shares you hold while increasing their price per share.

Why companies choose to perform reverse stock splits?

Companies often opt for reverse stock splits for several reasons:

  • Meeting exchange listing requirements
    Many stock exchanges have minimum share price requirements. If a company's stock price falls below this threshold, it risks being delisted. A reverse stock split can increase the share price, ensuring compliance with these regulations.
  • Improving investor perception
    A low share price can negatively impact a company's perception and deter potential investors, especially institutional investors who often have minimum investment thresholds. A higher share price, achieved through a reverse stock split, can enhance the company's image and attract a wider investor base.
  • Attracting institutional investors
    Many institutional investors, such as mutual funds and pension funds, have guidelines that limit investments in low-priced stocks. A reverse stock split can make the company's shares more attractive to these large investors.
  • Reducing the number of shareholders
    By consolidating shares, a reverse stock split can reduce the number of shareholders, potentially simplifying shareholder communications and administrative processes.

While a reverse stock split can have these potential benefits, it's important to note that it doesn't fundamentally change the company's underlying value. The total market capitalization remains the same, and the split primarily affects the share price and number of shares outstanding.

Is a reverse stock split good?

The answer is not a simple yes or no. Here is why:

  • No change in company value: A reverse split does not make the company more valuable. It is a financial manoeuvre, not a reflection of the company's actual performance.
  • Can signal trouble: Sometimes, a reverse split can be a sign that a company is struggling financially. Investors might see it as a last-ditch effort to make the stock more appealing.
  • Short-term volatility: The news of a reverse split can cause temporary fluctuations in the stock price. So, you must be prepared to weather the storm.

Should you sell before a reverse stock split?

There is no one-size-fits-all answer. Here are some factors to consider before you make a decision:

  • Reason for the split: If the company seems financially sound and the split aims to meet exchange listing requirements, it might not be a reason to sell. But, if the split seems like a desperate attempt to inflate the share price, you might want to re-evaluate your investment strategy, which we will discuss below.
  • Your investment strategy: Are you in it for the long haul or looking for short-term gains? A reverse split might cause short-term volatility, so factor that into your decision.
  • Do your research: Don't just react to the news of a reverse split. Research the company's financials, understand the reasons behind the split, and then make an informed decision.
  • Consider the tax implications: Depending on your location and tax situation, selling before a reverse split might have tax consequences. Consult a tax advisor to understand how the split might affect your tax burden.
  • Look for alternative indicators: A reverse share split shouldn't be the sole factor driving your investment decisions. Focus on the company's fundamentals, its competitive landscape, and long-term growth potential. A reverse split might not be a deal-breaker if the company demonstrates strong overall performance.

Also read: Stock vs bond

Advantages and Disadvantages of Reverse Stock Splits

Advantages

  • Avoiding delisting: If a company's share price falls below a certain threshold, it risks being delisted from the stock exchange. A reverse stock split can increase the share price, helping the company avoid this fate.
  • Attracting institutional investors: Many institutional investors, such as mutual funds and pension funds, have minimum investment requirements. A higher share price, resulting from a reverse stock split, can make the company's stock more attractive to these investors.
  • Regulatory compliance: In some cases, companies may use reverse stock splits to reduce the number of shareholders, which can simplify regulatory compliance and potentially lower regulatory costs.
  • Boosting spinoff prices: If a company plans to spin off a division, a reverse stock split can increase the share price, making the spinoff more valuable.

Disadvantages

  • Negative perception: Reverse stock splits are often viewed negatively by investors, as they can signal financial distress or poor management.
  • Reduced liquidity: A reverse stock split can reduce the number of shares available for trading, which can lead to lower liquidity and higher transaction costs.
  • No fundamental change: A reverse stock split does not change the underlying value of the company. It simply increases the share price while reducing the number of shares.

Taking action after a reverse stock split

  • Monitor the share price: As mentioned earlier, a reverse split can cause short-term volatility. Keep an eye on the stock price after the split to see how the market reacts. This can help you gauge investor sentiment and identify potential buying or selling opportunities.
  • Stay informed: Continue to follow the company's news and announcements. Look for any updates on their financial performance, future plans, or other factors that might affect the stock price.
  • Reassess your investment thesis: Did the reason for the reverse split change your perspective on the company? Has there been any significant news that alters your investment outlook? Take some time to re-evaluate your investment thesis and adjust your strategy as needed.

Limitations of reverse stock splits

While reverse stock splits offer certain advantages, they also come with limitations and potential downsides:

  • Temporary price increase: The initial increase in share price following a reverse stock split is often short-lived. While it may attract short-term traders, it may not necessarily attract long-term investors.
  • Perception vs. reality: A higher share price can improve a company's perception, but it doesn't change the underlying financial health or fundamentals. Investors should conduct thorough research to avoid being misled by the appearance of a higher share price.
  • Risk of further decline: If a company resorts to a reverse stock split due to consistent price declines, it may not address the root causes of these declines. In such cases, the stock price could continue to fall even after the split.
  • Shareholder dissatisfaction: Shareholders may be unhappy with a reverse stock split, especially if it reduces the value of their holdings. This can lead to dissatisfaction and potential legal challenges.
  • Potential for manipulation: Some companies may misuse reverse stock splits to manipulate their share price or attract speculative traders without any real improvement in the company's financial performance.

Significance of reverse stock splits

Reverse stock splits are significant for both companies and investors for several reasons:

  • Financial health assessment: For investors, a reverse stock split can be a signal of a company's financial health. If a company resorts to a reverse split, it may indicate underlying problems that warrant further investigation.
  • Market participation: Companies may use reverse stock splits to ensure they meet the listing requirements of major stock exchanges. This helps maintain their market presence and investor confidence.
  • Investment strategy: Investors should consider how reverse stock splits fit into their investment strategy. Depending on the company's motives and financial condition, a reverse split can be an opportunity or a warning sign.
  • Market dynamics: Reverse stock splits can affect market dynamics, including supply and demand for the stock. Investors should be aware of how such corporate actions might impact their positions.

Final thoughts

Reverse stock splits are a financial tool companies use to address specific situations. They don't inherently change the company's value or future prospects.

By understanding the reasons behind the split, conducting thorough research, and considering your investment goals, you can make informed decisions about whether to hold, sell, or even buy more shares after a reverse share split.

Read our popular articles:

What is a stock split?

What are bonus shares?

What is T2T stock segment?

What are mid-cap stocks?

Bajaj Finserv app for all your financial needs and goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

GET THE APP

Disclaimer

1. Bajaj Finance Limited (“BFL”) is a Non-Banking Finance Company (NBFC) and Prepaid Payment Instrument Issuer offering financial services viz., loans, deposits, Bajaj Pay Wallet, Bajaj Pay UPI, bill payments and third-party wealth management products. The details mentioned in the respective product/ service document shall prevail in case of any inconsistency with respect to the information referring to BFL products and services on this page.

2. All other information, such as, the images, facts, statistics etc. (“information”) that are in addition to the details mentioned in the BFL’s product/ service document and which are being displayed on this page only depicts the summary of the information sourced from the public domain. The said information is neither owned by BFL nor it is to the exclusive knowledge of BFL. There may be inadvertent inaccuracies or typographical errors or delays in updating the said information. Hence, users are advised to independently exercise diligence by verifying complete information, including by consulting experts, if any. Users shall be the sole owner of the decision taken, if any, about suitability of the same.

Standard Disclaimer

Investments in the securities market are subject to market risk, read all related documents carefully before investing.

Research Disclaimer

Broking services offered by Bajaj Financial Securities Limited (BFSL) | Registered Office: Bajaj Auto Limited Complex , Mumbai –Pune Road Akurdi Pune 411035 | Corporate Office: Bajaj Financial Securities Ltd,1st Floor, Mantri IT Park, Tower B, Unit No 9 & 10, Viman Nagar, Pune, Maharashtra 411014| CIN: U67120PN2010PLC136026| SEBI Registration No.: INZ000218931 | BSE Cash/F&O (Member ID: 6706) | DP registration No : IN-DP-418-2019 | CDSL DP No.: 12088600 | NSDL DP No. IN304300 | AMFI Registration No.: ARN – 163403|

Research Services are offered by Bajaj Financial Securities Limited (BFSL) as Research Analyst under SEBI Regn: INH000010043. Kindly refer to www.bajajfinservsecurities.in for detailed disclaimer and risk factors

This content is for educational purpose only.

Details of Compliance Officer: Ms. Kanti Pal (For Broking/DP/Research)|Email: compliance_sec@bajajfinserv.in/Compliance_dp@bajajfinserv.in |Contact No.: 020-4857 4486 |

Investment in the securities involves risks, investor should consult his own advisors/consultant to determine the merits and risks of investment.

Frequently asked questions

Is a reverse stock split a good thing?
A reverse stock split can improve exchange listing or attract some investors, but it doesn't change the company's value and might signal underlying issues.
Do investors lose money in a reverse split?
No, the total value of your holdings won’t change. However, short-term volatility after the split could lead to losses if you sell at the wrong time.
Do companies succeed after a reverse split?
Success depends on the company's fundamentals. The split itself doesn't guarantee success, but it can provide the company time to get back on track if used strategically.
Why Would a Company Undergo a Reverse Stock Split?

A reverse stock split is typically done when a company's share price falls too low, putting it at risk of being delisted from the stock exchange. This can happen due to various reasons, such as poor financial performance or negative market sentiment. By reducing the number of shares outstanding, a reverse stock split can increase the share price, helping the company meet the exchange's minimum price requirements. A higher share price can also attract institutional investors who often avoid low-priced stocks.

What Happens If I Own Shares That Undergo a Reverse Stock Split?

In a reverse stock split, the number of shares you own will decrease, but the value of your investment will remain the same. For example, in a 1:10 reverse stock split, if you own 1,000 shares worth ₹5 each, you will end up with 100 shares worth ₹50 each. Your broker will automatically adjust your holdings, so you don't need to take any action. A reverse stock split does not have any tax implications.

Why Does the ETN I Own Have So Many Reverse Splits?

Some exchange-traded products, like exchange-traded notes (ETNs), are designed to decay in value over time. This means that their value gradually decreases due to factors like fees and the nature of the underlying assets. To maintain a reasonable share price, these ETNs often undergo reverse splits. However, it's important to note that ETNs are not traditional stocks and are typically meant for short-term trading rather than long-term investment.

Show More Show Less