As an investor, you need to understand a lot of terminology. One of those terms is a stock split. This typically occurs when a stock is performing well. The number of shares outstanding is increased, and the stock price is reduced to a more attractive level.
But this isn’t the only type of stock split available. There is also a reverse stock split. This most commonly happens when a share price is struggling, and the company wants to make it look more attractive.
Keep reading as we explore reverse stock splits, why a company might want to complete one, a few recent examples, and, most importantly, how to profit from one.
What is a Reverse Stock Split?
When a company decides to perform a reverse stock split, it reduces the number of shares outstanding and increases the price per share. While everything is done in proportion, the company’s value remains the same, but the perception of its stock can be influenced.
The math behind a reverse stock split is simple. For example, let’s assume a company will go through a 1-to-10 reverse stock split, and the stock price is currently trading at $1.25. For every ten shares of stock you own, you will have one share after the split. However, instead of the price per share being $1.25, it will become $12.50.
Why Do Companies Do a Reverse Stock Split?
There are a couple of reasons why companies perform a reverse stock split. Most exchanges require companies to meet a minimum share price to remain listed. For example, the NASDAQ requires a minimum share price of $1.00. The company could be delisted if the price falls below this for 30 consecutive days. By using a reverse stock split, a company can increase its stock price over $1.00 to remain listed.
Most companies utilize a reverse stock split because their share price has fallen significantly. As a retail investor, you might stumble upon a company with a stock price of $0.75. While the company might be in an attractive sector with a lot of growth potential, a stock price this low can turn many people off. It makes it look like there are serious financial issues at the company (which there might be). By strategically increasing the share price, they’re able to attract institutional and retail investors.
Is a Reverse Stock Split Good?
If you’re an investor in a company announcing a reverse stock split, you may wonder if this is good or bad. The answer to this question isn’t exactly clear-cut. The reverse stock split itself isn’t a good or a bad thing. All it’s doing is adjusting the shares outstanding and the share price.
The outcome will help you decide whether a reverse stock split is in the company’s best interest. Most of the time, reverse stock splits happen because there is an underlying issue with the business itself. This is a way to give the company additional time to turn things around before it finds itself filing for bankruptcy.
While this might not sound overly encouraging, not all reverse stock splits are bad. Several have actually allowed businesses to survive, and today, they’re thriving companies.
Reverse Stock Split Examples
We’ve talked about how reverse stock splits are commonly a last-ditch effort to turn a business around. The truth is that most companies that perform a reverse stock split end up going bankrupt or being bought out by another company.
Here are a few notable reverse stock splits to know.
General Electric
Since the end of former CEO Jack Welch’s leadership, General Electric has been a struggling company. Although they sold several of their business units to boost profitability, their stock price has been hovering within a narrow trading range for years.
Then, in 2021, they decided to go through a 1-for-8 reverse stock split. This took their pre-split adjusted price of $12.69 and increased it to over $100 for the first time in years. Because the company had sold off several businesses, they felt the adjusted outstanding shares would better represent the overall business.
As of May 29, 2024, GE is trading at $163.60, showing that their decision to complete a reverse stock split wasn’t bad.
Booking.com
The Dot-com bubble was a significant period for the financial markets. From 1995 to 2000, the technology-heavy NASDAQ went from 1,000 listed companies to more than 5,000 due to a significant rise in investment in internet-based companies.
When the bubble finally burst in March 2000, Booking.com was one of many companies left trying to survive. In an attempt to get their finances in order, they bought some time by issuing a 1-for-6 reverse stock split. While many companies didn’t survive this period, Booking.com has been up more than 6,000% since hitting its bottom.
WeWork
Many of you might know the story behind WeWork. The flexible working space was once the most valuable startup, valued at $47 billion. However, as it planned to go public in 2019, investors became worried about their companies’ large losses.
Even though that initial IPO attempt didn’t happen, WeWork still ended up going public through a blank check acquisition at a much lower $10 billion valuation. By August 2023, WeWork found itself doing a 1-for-40 reverse stock split only to file for bankruptcy protection a few months later, in November 2023.
How to Profit From a Reverse Stock Split
Now that you understand the basics of a reverse stock split, you probably want to know if making a profit is possible. Unfortunately, profiting from a reverse stock split isn’t easy and far from guaranteed, but there are a few options.
Buy The Stock Before the Split
If your research leads you to believe that a company’s reverse stock split is part of its restructuring plans, like the case was with General Electric, you could purchase shares before the split. The hope would be that this would boost buyers’ confidence, sending the stock price higher. Just make sure you include this position in your stock portfolio tracker from Ziggma to ensure your portfolio is still optimally balanced.
Short the Stock
If you feel this is the beginning of the end for the company, you could choose to short the stock. When you short a stock, you borrow shares and sell them with the hopes you can buy them back later at a lower price. You’ll make money if the stock price declines after you short the stock. However, short selling is risky, and you should understand the risks involved beforehand.
Options Trading
You could use options to profit from expected volatility in the stock price. If you own shares of the stock, you could purchase put options, which will protect your investment from downside movement. If you want to skip purchasing shares of the stock, you could attempt to profit from a decline by selling put options. However, similar to short selling, it’s important to understand the risks of options trading.
The Bottom Line
Even though there have been some success stories, reverse stock splits are typically bad news for a company’s stock price. While there are some ways to profit, they include a lot of risk, so it’s important to research and ensure you’re willing to lose the money you invest.
