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Definition: Reverse Stock Split
Reverse Stock Split is a process by which a company tries to increase the market price of its shares by decreasing the number of outstanding shares in the market and increase the price per share. This is done by combining the current shares into fewer number of shares.
Although the price per share is now higher, the total value of the shares and the company still remains the same to an investor. A reverse stock split does not indicate a good financial health of the company. This is usually done to boost the share price in order to avoid being delisted from an exchange or to boost the quarterly numbers.
To illustrate a reverse stock split,
(i) Before the reverse stock split: Suppose you own the 100 shares of a company ABC Ltd., and the value of each share is Rs. 10. The total value of the shares is Rs. 1000.
(ii) After a 1-for-5 reverse stock split: The number of shares you own are now reduced to 20 shares of ABC Ltd., however, the value of each share now is Rs.50.
The total value of the shares is still Rs. 1000. Thus, although the price per share has increased, due to a proportional reduction in the number of shares the net worth still remains the same.