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Shame on you, AIG (NYSE: AIG ) .
The disgraced insurer had the gall to put investors through a humbling 1-for-20 reverse split last week, and its stock has been tumbling ever since.
It's true. AIG swapped out every 20 shares that closed at $1.16 at the end of June for a single share worth $23.20 immediately after the reverse split. It's a zero-sum game, in theory. Multiply the share price by 20. Divide the shares outstanding by 20. It all adds up in the end, right?
Well, good luck selling that to AIG shareholders. The stock has fallen sharply in three of the first four trading days since the reverse split, more than 40%.
Naturally, this is going to create a rallying cry from shareholders in companies like Sirius XM Radio (Nasdaq: SIRI ) that have been weighing reverse splits. Rite Aid (NYSE: RAD ) actually shelved plans to go through with a reverse split. Some investors would rather risk a delisting than go through a reverse split. They never stop to think that maybe the shares drop because the company is still crummy.
In other words, it's not the reverse split. If gravity is pulling you to zero, a reverse split isn't going to save you. On the other hand, it may be a fortifying move for a stock that isn't ready to be buried just yet.
Coeur d'Alene Mines (NYSE: CDE ) tired of trading for pocket change two months ago. Officials at the silver mining specialist initiated a 1-for-10 reverse split, after the stock closed at $1.40 on May 26. Repriced at $14, the stock actually rose in three of the next five trading days. It peaked at $15.55 a few days later.
If you think I'm going to butter you up with a happy ending, I'm not. Coeur d'Alene Mines closed at $11.27 Tuesday, nearly 20% off its post-reverse price. Don't blame the split, though. Silver prices have taken a tumble over the past month, fully explaining the stock's perhaps-temporary decline.
Again, it all comes down to the fundamentals.
If you want the "and the shareholders lived happily ever after" resolution, we'll have to dust off the library shelves to crack open the Millicom (Nasdaq: MICC ) and Priceline.com (Nasdaq: PCLN ) stories.
Luxembourg's Millicom used to be an out-of-favor cellular company. Its stock traded for as little as $0.25 a share in October 2002. Five months later, company management had had enough. The stock had bounced back to trade just shy of $2, but Millicom still went ahead with a 1-for-3 reverse split.
It was a timely move. Millicom was one of the market's biggest winners in 2003, closing at a whopping $70 price tag. Just a couple of days after the first anniversary of its reverse split, Millicom had the flexibility to declare a more conventional 4-for-1 split.
Millicom's doing just fine these days, and investors who held through the reverse split are now sitting on roughly a 40-bagger.
Priceline.com had a 1-for-6 reverse split in June 2003, after management watched the stock trade below the $5 mark for more than a year. The travel portal certainly wasn't cursed by going in reverse. It trades in the triple digits today.
Reverse splits didn't get in the way of our newsletter advisors hopping on: Millicom is a Motley Fool Global Gains recommendation and Priceline.com is a market-beater on the Motley Fool Stock Advisor scorecard.
In a nutshell
There are more losers than winners after reverse splits, but consider the source. Many of these companies have wronged their investors, which is why they're trading for pocket change in the first place. Did anyone really think that a reverse split would come with amnesia pills so we would all forget AIG's costly collapse?
Sun Microsystems (Nasdaq: JAVA ) had a 1-for-4 reverse split nearly two years ago. It's trading lower than its split-adjusted price today, but the same can be said of most tech stocks. In the end, it didn't get in the way of a buyout bid.
A CNBC report revealed that most of the recent reverse splits have resulted in lower adjusted prices during the first few days after the event. This makes sense. It shakes out the speculators. The penny-stock gamblers go away. However, if the stock is truly valuable, the higher price eventually will open the door for greater institutional investing and perhaps even wider analyst coverage.
I can sympathize with the Sirius XM shareholders who dread a reverse split. Seeing this month's implosion of AIG is scary. However, if Sirius XM is able to deliver on its promises of improving cash flows and finds a way to get its subscriber base growing again, fundamentals -- not any kind of split -- would dictate the stock's direction.
Other reverse handoffs: