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These Reverse Splits Are Not What They Seem

Selena Maranjian
October 10, 2011

Reverse stock splits are often viewed solely as bad news for stocks. And unbeknownst to many, even exchange-traded funds (ETFs) execute reverse splits. With both groups, reverse splits can be cause for a little more investigation, but they're not always purely bad news, especially for ETFs.

Consider this news: The folks at Direxion, which offers a bunch of highly leveraged bullish and bearish ETFs, have just announced plans to execute reverse splits for six of their funds. Five, including the Direxion Daily Financial Bull 3x Shares ETF  (NYSE: FAS  ) , will be splitting 1-for-5. Another, the Direxion Daily Russia Bull 3X Shares ETF, will split 1-for-3. What does it all mean?

Putting it in context
A traditional stock split, such as the 2-for-1 split that Freeport McMoRan Copper & Gold (NYSE: FCX  ) executed early this year, often gets investors excited, but it's really not too meaningful. If you had 100 shares of Freeport when it closed at $114 per share on Feb. 1, you had $11,400 worth of stock. The next day, after the split, the stock opened at about $57 per share, which is half of $114. You may have been suffused with glee to now see 200 shares in your portfolio, but 200 times $57 is ... $11,400. The overall value of your shares didn't really change.

Companies do stocks split for various reasons, sometimes in order for their shares to be more affordable. Google shares, for example, were recently trading above $500 per share, making some people feel unable to invest in it (even though you can buy just one share of a stock). Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) class B shares were trading around $3,500 per share until the company split them 50-to-1 in early 2010, thereby reducing them to around $70. (The catalyst was the purchase of the Burlington Northern railroad, which required small payments of stock to shareholders.)

The red flag
Reverse splits, though, are another beast. While you shouldn't get too excited about a regular split, you should take a close look at a reverse split, as it's often executed by a company in trouble, in order to prop up its stock price and make it look more respectable -- or to enable it to meet stock exchange listing requirements.

Many well-known companies, including E*TRADE (Nasdaq: ETFC  ) and Citigroup, have executed reverse splits when they weren't at death's door -- albeit with mixed success. Not so long ago, Sirius XM Radio (Nasdaq: SIRI  ) looked like it might do well to execute one. It's now in better shape, although its conservative projections are worrying some investors.

Meanwhile, having gobbled up Global Crossing, Level 3 Communications (Nasdaq: LVLT  ) is executing a 1-for-15 reverse split, which will boost the stock's recent price of $1.70 per share to roughly $25, a much more dignified level. As the company expands its content delivery networking business, it has attracted more believers.

Beleaguered transportation company YRC Worldwide executed a 1-for-25 one last year and with its stock all the way down near $0.06 per share, it's considering another one -- a whopper, too. Its shareholders are being asked to approve a split of up to 1-for-300. The stock seems to be