It was the best of times for Starbucks (Nasdaq: SBUX ) . It was the worst of times for LookSmart (Nasdaq: LOOK ) . As investors cheered yesterday's announcement that Starbucks would be splitting its shares 2-for-1, it wasn't exactly euphoric in the LookSmart camp: The fledgling paid-search specialist revealed that it had filed with the SEC to effect a reverse stock split.
You're a smart investor. You know the drill. Stock splits are zero sum games. Starbucks will still be an $18 billion company whether it's 384 million shares at $46 or 768 million shares at $23. The same goes with reverse splits. LookSmart will still be a $100 million company whether it's 114 million shares at $0.82 or 16.3 million shares at $5.74 apiece.
Mathematically, splits mean little. However, the market's perception tells a different story. A stock splitting is seen as a winner. It's a company that has seen its stock appreciate in value and feels confident enough about its future to slash the price of its stock so it can start all over again. A reverse split is seen as a failure. It's the white flag being waved by a company that couldn't boost its share price organically, so it has to fake it to get out of the penny stock muck that it got itself into.
Stocks that split often go on to split again. Stocks that go for a reverse split? Well, history has not been as kind. Sure, you have companies such as InfoSpace (Nasdaq: INSP ) and Click Commerce (Nasdaq: CKCM ) that have come back even stronger than before. Click Commerce, in particular, had created such a favorable niche in the promising RFID field that it was recently recommended in the Motley Fool Rule Breakers newsletter service.
That's why I'm not entirely down on the downtrodden companies that turn to reverse splits as their last hopes. However, except for a few companies like Tucows (AMEX: TCX ) , I wouldn't recommend it. In Tucows' case, you have a profitable company with just too many shares outstanding. It may be the best company that a buck can buy these days, but it would be interesting to see a reverse split effectively price the company at a point where it would be attractive to institutional money managers and conventional investors.
You also won't find me saying a bad word about Priceline.com (Nasdaq: PCLN ) , another company that turned to the reverse split two years ago so it wouldn't have such an embarrassing single-digit share price relative to its online travel rivals.
I'm almost willing to let LookSmart slide as well. It's not its fault that the stock cratered after Microsoft (Nasdaq: MSFT ) dumped it as a paid-search partner in order to pursue in-house solutions. The company has made some headway recently. I dig its vertical search approach to creating proprietary content, and its Furl Web-based bookmarking application is brilliant. If it's able to turn the corner, it will be served well with a reverse split to shed that intimidating number of outstanding shares.
However, for the rest of the penny stock pretenders out there, I have two words of advice when considering a reverse split: Earn it.
Longtime Fool contributor Rick Munarriz fancies banana splits over stock splits. He does not own shares in any of the companies mentioned in this story.
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