Definition of a Reverse Stock Split
Companies issue stock as a way to raise money to invest in their operations. As a company experiences successful growth and income, the price of a share of stock increases. If a stock price gets too high, investors may consider it too expensive to buy. In such cases, a company may "split" the stock. The number of shares increases, but the total dollar value remains the same. In certain circumstances, companies can also do the opposite and execute a "reverse stock split."
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Definition
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When a reverse stock split is done, stockholders end up with fewer shares, but the same total value. For example, suppose a stockholder has 100 shares valued at $2 per share, for a total of $200. Should the company do a "1-for-2" reverse stock split, the shareholder ends up with 50 shares valued at $4 per share. His total investment still remains at $200.
Purpose
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A stock price that is very low may appear unattractive to potential investors, and one way for a company to raise the price of a share of stock is to do a reverse stock split. Another reason a company may execute a reverse stock split is to raise the price of its shares above the level where they run the risk of being "de-listed," that is, kicked off of a major stock exchange, such as the New York Stock Exchange.
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Warning
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An investor must be cautious when considering buying shares of stock in a company that recently executed a reverse stock split. Often, companies that are in financial trouble will do a reverse split to make their stock appear to be more valuable. However, the reversal doesn't help problems with their operations or finances. Before investing in such companies, evaluate the company's cash flow, financial strength, performance and the future outlook for the sector they are in (technology, pharmaceuticals, etc.).
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