In a reverse stock split, the company increases the share price by proportionally reducing the number of shares outstanding. For example, in a 100-to-1 reverse stock split an investor who owns 10,000 shares of XYZ stock priced at 10 cents per share will end up owning 100 shares of a $10 stock. A reverse stock split is generally considered a positive for several reasons.
Low-priced stocks are generally riskier than higher-priced stocks, so many investors shun them. Many institutions only buy stocks that sell for at least $15 a share. By increasing the stock price through a reverse split, a company makes its stock potentially available to more investors.
Video of the Day
Most stocks below $5 a share are not marginable. When the price is increased above $5 a share, many investors and traders may start buying the stock because it is marginable or increase their current positions by buying more on margin.
If a stock price drops too low, the company may be in violation of listing compliance, meaning that if its stock price does not increase above a certain threshold by a specified deadline, the stock may be delisted from a stock exchange. Delisting is often a death blow to the shareholders, who won't be able to buy or sell the stock. A reverse stock split may save a company from delisting.
Access to Financing
A company in financial trouble may be in need of a capital injection to survive, but potential investors will want assurances of a reasonable return on their investment. A low stock price is a disincentive for them to invest. A reverse stock split may make it possible for a company to attract investors and raise capital.
Sign of Turnaround
A low stock price, particularly in a well-established company, is often a sign of financial trouble. A reverse stock split by itself will not save the company, but it is often an indication that the management is taking steps to reverse the slide and turn things around.