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Reverse Splits Aren't Always Fatal

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Some quarterly reports will make your head spin.

I was mid-Exorcist on hearing that AIG (NYSE: AIG  ) posted a profit of $2.30 a share in its latest quarter. Wasn't the disgraced insurer trading for a buck and change earlier this summer? Did it actually earn more in a single quarter than its share price?

The spinning was short-lived. I quickly realized that AIG had declared a humbling 1-for-20 reverse split recently, so a profit of $2.30 a share for the insurer today is actually $0.115 a share in June dollars.

However, seeing AIG's stock trade as high as $28 this morning now finds me clearing room in my "exception to the rule" mantelpiece. For now -- at least -- AIG has become one of the rare companies to subject shareholders to a reverse stock split and win.

Anatomy of a split
It wasn't pretty at first. AIG swapped out every 20 shares that closed at $1.16 at the end of June for a single share originally valued at $23.20. The first few trading days after the zero-sum move proved disastrous.

















How do you like the reverse split now, shareholders?

Not every reverse split has to have an unhappy ending. The reason the practice gets a bad rap is that it usually involves desperate companies that have fallen into the penny stock muck that resort to reverse splits. The reverse isn't the reason why the share prices continue to deteriorate. Blame inertia.

A lousy stock pre-split is going to be a lousy stock post-split. Fearing a reverse -- which in theory reestablishes a stock's price into buyer-conducive territory -- is like fearing your nudity. A share price is only as ugly as the stock buried beneath the clothing.

Don't shoot the message. Shoot the messenger.

Pedaling backwards
Now that the exchanges are once again threatening to delist stocks that consistently close below the price of $1 a share, expect more companies turning to reverse splits in the future.

"If in fact Sirius XM stock does not trade above $1, we would have to take actions which would mean a reverse split within the next year," Sirius XM Radio (Nasdaq: SIRI  ) CEO Mel Karmazin told investors during this week's conference call.

This is the kind of talk that typically spooks investors, but why so tense? What is the difference between 4 billion shares at $0.50 and 400 million shares at $5 or 40 million shares at $50? The multiplication exercises result in the same market cap at the end. The only difference is that you swap out a few speculators, and replace them with investors.

Blockbuster (NYSE: BBI  ) hasn't traded for more than $1 a share since June. Jones Soda (Nasdaq: JSDA  ) broke under the dollar level four weeks ago. The fortunes may change for these companies, but they are probably reverse splits waiting to happen.

But it's not the end of the world. It's just the end of a share price.

Turning the hall of shame into the hall of fame
AIG isn't the only stock to go through a reverse split, only to trade higher. Coeur d'Alene Mines (NYSE: CDE  ) initiated a 1-for-10 reverse split, after closing at $1.40 on May 26. The silver mining specialist is trading higher than that split-adjusted $14 today.

If you're still all curled up like a Cheez Doodle, frightened to find one of your stocks going through a reverse stock split, be reasonable. At the very least, be honest. If you're afraid of what the market will dictate that your stock is worth -- sans penny stock speculators -- maybe you're holding the wrong stock.

A 1-for-4 reverse split didn't get in the way of a juicy buyout bid for Sun Microsystems (Nasdaq: JAVA  ) . (Nasdaq: PCLN  ) had a 1-for-6 reverse split in June 2003, and it's a fast-growing darling in online travel these days.

The more recent success stories of Coeur d'Alene and AIG will help break down the stigma.

You have nothing to fear but a fearful company itself.

Other reverse handoffs:

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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 (4) | Recommend This Article (8)

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 August 07, 2009, at 8:19 PM, ozzfan1317 wrote:

    Aig still has a pile of debt and a horrible balance sheet and I wouldnt be suprised if the profit was a one time deal. I still have no clue why anyone is buying I'm fairly sure it will be shorted excessively soon.

  • Report this Comment On August 07, 2009, at 11:02 PM, chbecker99 wrote:

    I dont understand the fear of a SIRI reverse split either.

    However, do we really think this stock will be less than $1 dollar in a years time.

    Nothing to worry about here.

  • Report this Comment On August 08, 2009, at 10:51 AM, cantbefoolish wrote:

    "What's the difference?" It's just more paperwork, for those of us who averaged down. Having to divide the cost basis many times. Other than that, I don't think people have a problem with it.

    However, it may not be necessary if SIRI can stay listed for one more quarter. With the current amount of subs, the revenues will go from $600 mil to over $700, based on the $2 music royalty fee. 18 mil subs X $2 is $36 mil, X 3 months = $108 mil. Right now, they have 18.4 mil subs. So, even with a net loss of 400k subs they will still make $108 mil more in the 3rd quarter, given that all subs will be charged the $2 royalty fee.

  • Report this Comment On August 08, 2009, at 12:22 PM, paultaut wrote:

    I guess you've never heard of AT&T either. The last time around (2002-3) with T trading around $3, they did a 1 for 5 reversal.

    Not much changed in between considering where they are at now. Its not the reverse split that matters, its the reason behind the reverse.

    Take CDE, as a penny stock: analyst coverage, Mutual Fund ownership, the ability to issue Debt were all compromised. As a stock above $10, it now garners the exposure it needs to raise additional capital. I was hoping for at least a 1 for 5, 1 for 10 was even better. Earnings of $0.017 would have barely registered. 17 cents sounds much better.

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