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Why These Splits Should Scare You

Dan Caplinger
September 25, 2012

Stock splits have long been a controversial topic among investment analysts. Despite having no real impact on a company, investors perceive splits as more than just a cosmetic change in the number of shares outstanding and current price of those shares.

From a regular stock split, investors often infer the prospect for substantial future growth. But with reverse splits, the opposite feeling of pessimism can be much stronger -- and with exchange-traded funds that do reverse splits, those feelings are justified.

Recently, the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX  ) announced it would do a 1-for-4 reverse split next week. As the second such reverse split in less than two years, the obvious question for investors is what the repeated need for such action makes this and similar exchange-traded products a bad investment. I'll take a stab at answering that question below, but first, let's look at splits a bit more closely.

Reverse splits and you
Stock splits used to make a lot more sense than they do now. In the past, full-service brokers preferred to trade in round lots of 100 shares, and so once a stock's price got too high, it got difficult for ordinary investors to afford a full 100-share lot. Splits helped bring prices back into line. With discount brokers making it easy to buy smaller numbers of shares, the need for stock splits largely went away.

But reverse splits still serve a vital purpose. When a stock's price gets too small, a company risks getting its shares delisted from the exchanges on which it trades. Sirius XM (Nasdaq: SIRI  ) , for instance, almost required a reverse split to get its stock price above the key $1-per-share mark before finally eclipsing the level without assistance. Moreover, a reverse split doesn't have to be a death knell, as the experience of (Nasdaq: PCLN  ) and its 1-for-6 reverse split during the tech bust shows.

Because a reverse split is only needed