The Anatomy of a Reverse Stock Split
A reverse stock split sounds complex, but it's fairly straightforward. We explain what happens in a reverse stock split and some reasons why a company might do one.
March 11 2021, Updated 1:17 p.m. ET
General Electric (NYSE:GE) is the latest in a line of reverse stock splits that have propelled company shares to a new price class. But what does a reverse stock split really mean?
Effectively, a reverse stock split increases the share price while reducing the number of total shares available by the same ratio. It's the opposite of a regular stock split, in which the price of a share decreases but the total number of shares available increases. With a reverse stock split, shareholders maintain the same total equity—it's just arranged differently.
Examples of reverse stock splits in the market
Usually, reverse stock splits occur when companies have low share prices and need a way to maintain stock exchange approval. Stock exchanges tend to have a minimum share price that eliminates penny stocks from the running.
HUMBL Inc. (OTC:TSNPD) performed a 1-for-4 reverse split at the same time they shifted from their previous name of Tesoro Enterprises Inc. Both the name change and the stock split confused investors, but their securities retained the same value (excluding market changes).
China SXT Pharmaceuticals Inc. (NASDAQ:SXTC) performed a 1-for-4 reverse split in 2021, too. Their Mar. 10 share value was $1.96.
However, GE wasn't a penny stock and still performed a reverse stock split to increase their share price. Reportedly, GE wanted to align their number of available shares with others in the large-cap sector for a more accurate competitive representation. There's also something to be said for sentiment of higher share prices.
The outcome in a 1-for-8 reverse split
In GE's case, shareholders with eight shares will come out of the reverse split with one share. However, the total value will remain consistent. For the company, their existing 8.8 billion outstanding shares outstanding will come down to 1.1 billion. This is appropriate for their approximately $116 billion market capitalization. Other companies with similar capitalizations have hundreds of millions of shares (not multiple billions), so this makes sense.
Is a reverse stock split good or bad for investors?
Like many pivots in investor relations, a reverse stock split can be good or bad depending on the context. It can be a red flag for a company with a dwindling share price caused by underlying fiscal health problems. After all, a reverse stock split is a manufactured boost in share price—not a natural market inflation. If something is going on below the surface, a reverse stock split won't fix it.
In some cases, there's a legitimate reason why shares require consolidating. It's important for investors to keep their eyes on earnings reports to understand the goings on.
Ultimately, reverse splits can work, but only if they're done for the right reasons.
Can investors make money on a reverse stock split?
Reverse splits are not inherently lucrative. Whether or not you make money on the process depends on market response.
Should investors sell stock before a reverse split?
If a penny stock from a struggling company is taking on a reverse split, it may be a good time to sell before the bear comes. However, an established company taking a reverse split could be an opportunity for growth. In that case, hold on.