Reverse stock splits are often a major concern for investors as it signals a struggling business. They are often a last resort for most publicly traded companies. A struggling volatile company may decide to enact a reverse stock split in order to bring about future stability to the company through a short term increase in share price through the consolidatation of outstanding shares.
Reverse stock splits do not inherently add any additional value to the company but it helps keep the stock compliant with exchange listing requirements of those in the NASDAQ, or NYSE. It could also potentially open up the door to future capital raising opportunities.
Lets break down the spiral of how it works, and what it could potentially mean for you as an investor.
What is a Reverse Stock Split?
A reverse stock split (simply put) is when a company reduces the number of its outstanding shares while simultaneously increasing the share price by the same factor.
Think of it like receiving multiple smaller shares for fewer, higher-priced shares, there is no inherent additional value but the perception of the value would change.
Example:
- Lets say you hold 1,000 shares of a company at $0.50 each, a 1-for-10 reverse stock split would leave you with 100 shares at $5.00 each.
- The company’s overall market capitalisation remains unchanged (at least initially).
Why Do Companies Perform Reverse Stock Splits?
1. Preventing Delisting From Major Exchanges
Falling below minimum share price thresholds (typically $1 for NASDAQ and NYSE) can trigger a delisting notice directly to the company. A reverse split is the easiest way to help companies meet these requirements and remain listed.
2. Attracting Institutional Investors
Institutional investors are the market drivers of a stock. Many large funds won’t touch stocks under $5. Reverse splits are an easy method of increasing the share prices above this cutoff, opening the door to a broader range of potential investors.
3. Improving Perception
Trading below a few dollars per share carries a stigma (a penny stock is not always a positive), often associating companies with financial distress and therefore a financial risk investment. A higher nominal share price can improve a company’s image.
4. Corporate Restructuring Signals
Sometimes, reverse splits are part of a larger financial restructuring or turnaround plan aimed at reducing debt or streamlining operations.
Do Reverse Stock Splits Work?
The Reality:
While reverse stock splits can provide short-term benefits, such as avoiding delisting and temporarily boosting investor confidence, they don’t fix underlying business problems.
- NASDAQ data shows that companies performing reverse splits underperform the market by 15-20% over the following year.
- Only about 30% of companies see long-term stabilisation post-split, usually when accompanied by broader operational changes.
Reverse Stock Split Success Stories
1. AIG (2009)
AIG was once considered “too big to fail”, but during the later part of the 2008 financial crisis, AIG’s stock had plummeted to below a measly $2. The company implemented a 1-for-20 reverse split, helping it avoid delisting and stabilise while undergoing a major government backed restructuring. Over the following years, AIG’s recovery saw its stock rebound significantly. Read more about AIG’s comeback
2. Citigroup (2011)
Citigroup executed a 1-for-10 reverse stock split in 2011, raising its share price from around $4.50 to over $45. The move supported a broader recovery strategy that included asset sales and capital improvements. Today, Citigroup is once again a major player in global banking. Citigroup’s split details
3. Laboratory Corp. of America (2000)
Back in 2000, LH, was facing financial instability. LH decided to implement a 1 for 10 reverse stock split in order to regain compliance and attempting to improve investor sentiment. The company was one of the rare occasions of a reverse stock split going well, with major recovery and even performed several stock splits since as the share price has continued to rise.
As of today, LH is valued at $218 a share, showing great management and recovery.
Reverse Stock Split Failures
1. Eastman Kodak (2013)
Kodak is a company that has struggled for a long time. It completed a 1 for 4 reverse split as part of its efforts to regain NYSE listing status and pivot into new markets. However, poor revenue growth has continued to plague the company, not helped by stiff competition in its sector. Kodak’s stock has continued to struggle as of today.
2. Virgin Galactic (2024)
In 2024, Virgin Galactic stock (SPCE) decided to undergo a 1 for 20 reverse stock split in order to boost their overall share price in order to comply with NYSE requirements. The stock was trading at $1, post split, this would mean if you held 1 share at $1, you would now have 0.05 shares with a new full share price of $20.
As of June 2024, the stock price has again sank to $11.34, reflecting ongoing skepticism about the future prospects of the company and their ability to reach sustainability.
Should Investors Worry?
Reverse stock splits are not always bad, but they’re often a red flag for a company you should avoid. It would be best to focus on a company’s fundamentals, management, and industry to get a better idea of the company potential:
- Is there a clear turnaround plan?
- Are revenues and earnings improving?
- Is management addressing the root causes of the share price drop?
If the reverse split is part of a broader recovery strategy, it could signal opportunity. If not, caution is warranted.
Final Thoughts
Remember that reverse stock splits are tools that can help companies regain compliance and reposition themselves as required for listing. It is not always an outright signal to avoid a stock but often one of the greatest indicators of a highly volatile, risky stock that is probably best avoided.
For more market insights and financial analysis, check out our latest posts or visit platforms like Yahoo Finance.
Also check out my other article on red flags to avoid with companys
