A reverse stock split occurs when the issuing company exchanges a larger number of shares for a smaller number of shares. The stock price will increase as a result of the reverse split. There are several reasons for doing so, such as:
- The shares had previously been trading in the penny stock range, where many investors do not want to conduct trades.
- An underwriter for a company wanting to go public recommends a reverse stock split in order to bring the stock price into a range that investors would be willing to purchase.
- The exchange on which a company's shares trade has a minimum bid price, and the company's shares have fallen below that price.
- The company can eliminate smaller shareholders whose holdings are now less than one share.
For example, an investor holds 100 shares of stock that are currently trading at $2 each. The market value of these shares is $200 (calculated as 100 shares × $2 each). The issuing company decides to initiate a 10-for-1 reverse stock split. This means that the investor swaps out his old certificate for 100 shares for a new one for 10 shares. The market price increases to $20 to reflect the reduced number of shares, which means that the investor still has holdings worth $200 (calculated as 10 shares × $20 each).