Why Are You Afraid of Reverse Splits? 

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.

Silver bullets
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:

Try any of our Foolish newsletters today, free for 30 days.

Longtime Fool contributor Rick Munarriz thinks that thinking about splits can give you a splitting headache. He does not own shares in any of the stocks in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 08, 2009, at 3:48 PM, detroitone wrote:

    Dead on point, this is the first time I agree with Motley

    I think shareholders should sue AIG at least the ones that counldn't vote or was out of the loop until after the split like I was. I would put a ClassAction lawsuit against them that way fear would trickle to those company's that are in favor of a reverse split espeacilly if their balance sheets are not on point. I think reverse splits are a way to get shareholders at zero and start all over again with fresh new comers it's all bologne at this point.

  • Report this Comment On July 08, 2009, at 5:48 PM, ralston3057 wrote:

    Why are you guys MORONS? That should be the title of your article. Why are the MF writers Morons???

    That being said, you can consider me a moron for reading your crappy articles and leaving comments. Good Day.

  • Report this Comment On July 08, 2009, at 6:44 PM, saxman00007 wrote:

    The Motley Fool is indeed comprised of multiple Fools. The sad thing is you point the market in the direction that is self fulfilling. The sad , very sad, part, you characrters cost people hard earned money and you know little, if anything about the market but you make your commentaries of about every stock in the market. Regarding the article dealing with reverse splits of today, have the author thereof commited to Camirillo and/or Belleview. Then have the rest of your fools checked out.

    A seasoned investor , C.P.A., M.B.A.

  • Report this Comment On July 08, 2009, at 8:27 PM, otto8384 wrote:

    Rick - I have to say I enjoy reading your articles whether I agree w/ them or not & don't deny the fact you're a talented writer. I'm sure it's good for TMF since I would think every click brings in revenue in some shape or form & I'm sure that helps to continue paying your salary. But it would be interesting to read your response to the following: Both XM and SIRI reached 'peak' market caps of nearly 8-9B as individual entities, each w/ less revenues & obviously less than 1/2 the assets of the current newly merged company (don't tell me the satellites aren't worth anything -- someone is interested in them- maybe a guy named Malone or even Ergen). Their debt structure as individual companies were still both horrendous (so how did each reach such a high "market cap" in the 1st place?). I could care less if the company does an RS or not -- If it does and the market cap went to even 1/3 of its former 'peak', this would put the current adjusted share price at $1, making the de-listing issue a mute point anyhow. Having said that, tell me how the newly joined company now all of a sudden commands a market cap of around 1.5B. In your answer, don't use the phrase "formerly overvalued" unless you can also use the term "currently undervalued" in the same sentence. And feel free to use "naked short selling" and stock price (or market cap) manipulation as well. But writing the truth wouldn't be nearly as entertaining. Bottom Line -- If there are only 1B outstanding shares and Wall Street 'assigns' a FAIR market capitalization of even 4B or 5B, then the stock price would be $4 or $5. So at the same market cap, at current 4B shares you get at least a $1 price -- no de-listing. A company this size w/ a REAL product, market and potential deserves better than the pink sheets.

  • Report this Comment On July 08, 2009, at 11:31 PM, BigVincent wrote:

    Rick, or Should I call you Ricky Bobby. Your writing is as much a disaster as Ricky Bobby is to NASCAR in taladega nights.

    I my self am a siri/XM investor that is heavily invested. Bought the stock as low as .05 cents a share when people feared that it was doomed.

    Reverse splits are a good thing, a positive thing. It consolidates shares, it makes it stronger than it would if I had smaller multipiles caused by dillution.

    Now the down side is that I as well bought the shares at 7.00 almost 4 years ago. As a long investor I will probably never see the return on that $7.00, being a long investor. Look at the bright side though, I was able to buy 100 fold the amount of stock at .05cents than I could at $7.00.

    The money I lost at $7.00 doesn't matter any more, but that is the main concern of fear that is instiled in the long term siri investor. For those that bought most recently it's a win, win situation.

    I find it funny how you call shots out at the siri investors claiming that they are in fear of a R/S. You really need to find a career that you could be good at because mysekf as well as other investors are getting tired of your lies and spin on the truth.

  • Report this Comment On July 09, 2009, at 1:22 PM, michaelh2001 wrote:

    Thank you for your timely article. As a SIRI shareholder - albeit relatively small with 472 shares - I have been wondering how a reverse stock split would impact my investment. I'm also a customer of Sirius XM, and pay $12.95 a month to listen online. I subscribe because Sirius XM is the only 24/7 radio that is uncensored. As for my shares, I will hold onto them long term and probably buy more while they are low, because its my belief that as the economy eventually recovers and grows, so will Sirius XM's customer base and bottom line.

  • Report this Comment On July 09, 2009, at 2:35 PM, betweenthehedges wrote:

    Here is the problem with a reverse stock split and why it will not happen when Mel has options to purchase at 43 cents. After the reverse split, the stock is easier to borrow and more people get access to short it when it is trading at a higher price. I think that revenue projections are going to get better soon, but until the auto market starts booming again, I'm happy to keep my shares away from the shorts.

  • Report this Comment On July 10, 2009, at 6:59 AM, SIRIDoom wrote:

    FIRST MAN TO EVER DESTROY A MONOPOLY

    Yes, Mel Karmizine (Karmacrook) could go down in the history books as a big man. The first man in the history of the United States Stock Market to single handedly destroy a billion dollar corporation with monopoly over an entire industry.

    SIRI from 12.00 to 8 cents in 11 months.

    SIRI the only company to ever merge a bankrupt 11 billion dollar debt company XM, with a working model company SIRI.

    SIRI less than 8 months after the merger, Stock saturation over 83 percent in new issue and guarantees

    SIRI DEBT

    2010: ~$500mil in interest plus $350 in loans coming due

    2011: ~$500mill in interest plus $650 in bonds and loans due

    2012: ~$500mil in interest plus $500mil in bonds and loans due

    2013: ~$500mil in interest plus $1.8bil in bonds and loans due

    2014: ~$500mil in interest plus $555mil in bonds and loans due”

    Way to go Mel!!! Big Man!!!

    How about some news on the New Subscribers from the Ipod App.???

    Be ready to dump SIRI.

  • Report this Comment On August 06, 2009, at 3:21 PM, jissues wrote:

    Rick,

    I would love to sue AIG for that,. I invested money the day before they pulled this stunt, and I ended up selling my stock for a loss because it was headed for 0 after that, and of course now with the possible investment by another company recently the stock was up around $24. I am quite irritated with this irresponsible behavior, how would we go about suing them over this? I would love to join a class action suit against these morons!

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 936761, ~/Articles/ArticleHandler.aspx, 11/27/2014 3:06:21 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 16 hours ago Sponsored by:
DOW 17,827.75 12.81 0.00%
S&P 500 2,072.83 5.80 0.00%
NASD 4,787.32 29.07 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

11/26/2014 4:02 PM
AIG $54.61 Down -0.07 +0.00%
American Internati… CAPS Rating: ****
CDE $4.64 Down -0.15 +0.00%
Coeur d'Alene Mine… CAPS Rating: ***
JAVA.DL $9.49 Down +0.00 +0.00%
Sun Microsystems,… CAPS Rating: **
MICC.DL $0.00 Down +0.00 +0.00%
Millicom Internati… CAPS Rating: *****
PCLN $1166.83 Down -12.34 +0.00%
Priceline Group CAPS Rating: ***
RAD $5.60 Up +0.01 +0.00%
Rite Aid Corp CAPS Rating: ***
SIRI $3.60 Down +0.00 +0.00%
Sirius XM Radio CAPS Rating: ***

Advertisement