A reverse stock split has emerged as a tool used by companies to address issues associated with stock prices that are too low. On occasion, when a company's stock price has fallen well below the minimum threshold required by one of the exchanges its shares are listed on, the company may consider a reverse stock split as part of its plan to avoid delisting. In such cases, the company consolidates its existing shares of stock into fewer shares, thereby increasing the stock price.

A reverse stock split does not have any direct impact on a company’s fundamental value, but it can send a signal of distress to shareholders and the markets. In the case of a financially troubled company, for example, management may opt for a reverse stock split to increase the stock’s price in order to make it more attractive to retail investors. Similarly, a company may use a reverse split to boost its share price to meet the listing requirements of an exchange, such as the New York Stock Exchange or the Nasdaq.

The amount of the reverse stock split can vary and is determined by the company initiating the split. In most cases, if the decision to split the stock is made, the company typically sets the ratio at proportions such as 1-for-2, 1-for-3 or 1-for-10. This means that the company could convert one share of stock into 10 shares, two shares or three shares, depending on the ratio. The higher the ratio, the greater the impact the reverse split has on increasing the stock price.

For shareholders, the reverse stock split is not necessarily beneficial since it reduces their total number of shares, but it increases the shares’ value, so their overall financial holdings remain unchanged. Private investors may benefit, however, if the split works to boost the stock price and make a greater gain on their existing shares.

Reverse stock splits are often viewed negatively because they may be seen as a sign of a company’s recession and deteriorating competitive position. As a last resort, directors may implement these splits if they believe there is no other way to save the company. In most cases, a reverse stock split is a final effort by a company desperate to remain competitive and avoid being delisted.

Whether the strategy is successful or not, a reverse stock split highlights a company’s need for short-term gains and should be seen as a red flag for investors. While a reverse stock split may be necessary to prop up a company’s stock price and stay listed on an exchange, it is not typically a reliable strategy for long-term success. Therefore, investors should pay close attention to a company’s fundamentals and take their time to research and analyze any conditions that may have put the company in the position to consider a reverse stock split in the first place.