Reverse Stock Split

A reverse stock split is when a company combines multiple shares into one to increase the stock price. Unlike forward splits (which signal confidence), reverse splits often indicate distress.

How It Works (1:5 Reverse Split):

• Before: 1,000 shares at $2/share = $2,000 total
• After: 200 shares at $10/share = $2,000 total
• You have ⅕ the shares at 5× the price

Common Reverse Split Ratios:

• 1:5: 5 shares become 1 share
• 1:10: 10 shares become 1 share
• 1:20: 20 shares become 1 share (severe distress)

Why Companies Do Reverse Splits:

1. Exchange Listing Requirements: Nasdaq requires stocks to trade above $1/share. A reverse split can prevent delisting.

2. Improve Perception: Penny stocks under $5 are often perceived as risky. A reverse split can boost the price above $5 or $10.

3. Institutional Investor Requirements: Many mutual funds won't buy stocks under $5.

Warning Signs: Reverse splits are often followed by further price declines because:

• They don't fix underlying business problems
• They signal financial distress
• Investor confidence is usually low

Real-World Examples:

Citigroup (2011): 1:10 reverse split during financial crisis recovery. Stock was $4, became $40. Declined to $30 within months.

GE (2021): 1:8 reverse split to boost share price after years of decline.

Frequent Offenders: Small biotech companies and struggling retailers often reverse split multiple times.

What Happens to Fractional Shares: If you own 17 shares and there's a 1:5 reverse split:

• You get 3 whole shares (15 ÷ 5 = 3)
• 2 fractional shares become 0.4 shares
• Most brokers pay you cash for the fractional 0.4 shares

Tax Implications: Reverse splits are NOT taxable events. However, receiving cash for fractional shares IS taxable as a capital gain/loss.

Performance Statistics: Studies show reverse-split stocks underperform the market by 30-50% on average in the year following the split. They're often red flags.

The Bottom Line: Reverse splits are cosmetic fixes for low stock prices. They don't solve underlying business problems and often precede further declines. Proceed with extreme caution.