You already know we think stock splits are non-events, but what about their mirror image? After three years of a bear market, reverse splits have proliferated. They're quite definitely events, and not good ones.

Oh, delisting! Oh, the humanity!
An extended bear brings stocks to their knees -- often to pennies a share. Literally. And the lower they go, the less institutional investors are likely to hold them. When they drop farther still and trade under $1, the greater the threat that the New York Stock Exchange or Nasdaq will no longer list them.

Oh, what circles of hell await them! Once delisted from the Nasdaq, they may find refuge on the OTC bulletin board ("OTC BB"), if they are lucky, and then the Pink Sheets. The Naz has been talking about turning the OTC BB into a full-fledged exchange, with requirements 'n' everything. But until then, the BB is a less liquid and Wild Unregulated West for investors. Ditto the unrelated Pink Sheets, a 100-year-old stock quotation service that, at one time, indeed printed on pink paper.

On these markets, stocks are often so thinly-traded that they are said to "trade by appointment." That also means you may not find a buyer, should you want to sell -- at any price. And it absolutely means nausea-inducing volatility. Corporate financials? Scarce and often questionable. To invest in these worlds is to gamble where manipulation and fraud are rife -- as if the spate of OTC BB stock email spam didn't already convince you. And even with the occasional exception of a decent company that, for some reason, won't list itself on a grown-up exchange, I have to ask why anyone would take the risk.

Given this advice to pass up stocks listed on the BB or Pink Sheets, I'll add one more stat showing how poorly investors view such stocks. My research finds that 82% of the stocks traded over the counter sell for under $1 a share.

No wonder companies perform a reverse split to avoid delisting and relegation to a place where their shares are certain to languish. Many are in imminent danger of doing so:

  
    Exchange/
    No. of    No. <
    % < Market     Companies   $1/Shr.   $1/Shr.NYSE           2,144       27        1%Nasdaq         3,512      433       12%Amex             582      135       23%[Source: AAII, data as of March 7]

Doing the splits
In the more familiar stock split, a company issues shareholders some multiple of shares already owned, and cuts the stock price by a corresponding percentage so that the event is a wash. Microsoft (NASDAQ:MSFT) recently split stock 2-for-1, and on the effective date of the split, the stock began trading at half of its previous-day close of $48.30. While stock splits mean nothing for your ownership share, and we may think they are silly things to do, splits often occur when a stock has performed successfully and reached a high price.

The opposite is true of reverse splits, born when a stock is unsuccessful and has collapsed to a low price. A company reduces outstanding shares and increases the stock price by a corresponding percentage. For example, in a 5-for-1 reverse split, such as AT&T's (NYSE:T) a year ago, investors owned one-fifth of the shares they owned before, but at $24.85 -- five times the prior close of $4.97. Another wash. Lots of academic finance research reportedly shows that the stocks of most companies that reverse split continue to underperform the market averages. Reverse splits are acts of desperation by companies in trouble.

How are they doing?
I checked reverse splits for 2002. It sure was fun to read TheWall Street Journal stock listings and note every "rs" entry denoting reverse split. I have no doubt that I missed one or two, my eyes not being what they used to be.

I segregated the 37 companies whose pre-split price was under $1 a share. Only 14 are trading over $5 today, but surprisingly, 20 have outperformed the S&P 500. Here are the complete results:

  
                 % Change   % Change  Stock  MarketCompany       to 3/13/03  S&P 500  Price   Cap.
    Outperform S&P 500:                   ($mils.) Microstrategy    404%      -8%   $24.22   $328 Brightpoint      392%     -15%    13.46    108Telewest Comm.   215%       1%     8.20    108Ethyl            156%     -16%     9.60    161Infospace        105%      -6%     9.42    290Optical Cable     84%      -8%     3.54     20Cellstar          77%     -23%     6.20     81Orckit Comm.      69%      -9%     6.42     30Ista Pharm.       68%      -6%     5.55     87Blue Coat Sys.    67%      -7%     5.27     44Endwave Comm.     67%     -16%     1.05     10Sorrento Ntwks.   66%       1%     6.31      6Cosine Comm.      34%      -5%     4.69     46Onvia.com         30%      -8%     2.74     21Caldera Int'l     27%     -28%     2.70     32Stratos Lightwave 20%      -8%     3.12     22Copper Mntn.      18%      -8%     5.89     35Docent            14%      -7%     2.57     35The 3DO Corp.      6%     -14%     1.78     15Vyyo              -1%      -9%     2.37     30
  
                 % Change   % Change  Stock  MarketCompany       to 3/13/03   &P 500  Price   Cap.
    Underperform S&P 500:                 ($mils.)Sunday Comm.      -8%     -1%     1.80     54Click Commerce    -9%     -5%     2.64     21LM Ericsson      -11%     -7%     6.11 10,655Blue Martini     -19%     -6%     2.71     28Palm             -20%     -1%    10.26    293Trintech Group   -25%    -24%     1.71     26Collectors Univ. -25%     -9%     2.60     16Cytogen          -31%     -7%     2.96     26Vista Gold       -39%    -20%     3.30     32ChileSat         -48%     -9%     2.34    110
Commerce One -49% -7% 1.54 43Versata -49% -24% 0.79 6Nexprise -54% -26% 3.30 11Novatel Wireless -67% -7% 1.03 6Eurotrust AS -72% -9% 1.14 6Eresource Cap. -73% -17% 0.57 5Easylink -88% -26% 0.32 11

Conclusions?
Regardless of performance versus the S&P 500, these stocks hardly inhabit a territory of happy stocks and businesses. Twenty-four of these 37 companies are citizens of the land of penny stocks (stocks selling for under $5 a share) and penny companies (selling both for under $5 a share and with a market cap under $250 million). The vast majority are microcaps, perfect candidates for manipulation and fraud. Thus, any positive performance against the averages provides limited comfort.

Of course, because I'm an ex-lawyer, I'm genetically incapable of categorical statements, and have to admit that there will be exceptions. In the very rare case, it appears that a company may turn itself around post-reverse split and draw back investors. Take the best performer here, business-intelligence software maker Microstrategy (NASDAQ:MSTR). It was a bull market darling discovered to have cooked its books. Yet, it does have one of the leading business-intelligence software packages, which companies buy and then pay license fees to Microstrategy.

If you do some research, decide to forgive Microstrategy's sins, and determine it may be able to bolster its competitive position versus market leaders Cognos (NASDAQ:COGN) and Business Objects (NASDAQ:BOBJ), you might decide that the reverse split, in this particular exception, doesn't doom the company as an investment. But this would be a very rare exception.

Have any experience with reverse splits? We want to know on the Fool on the Hill discussion board.

I wish you a most Foolish week in these dramatic times.

Today is Tom Jacobs's (TMF Tom9) 47th birthday. If he split two-for-one, he'd be 23.5, but if he reverse split one-for-two, he'd be 94 -- about the age of his delightful great aunt Harriet. You may send greetings to him at tomj@fool.com, and large denomination bills to him at Fool HQ. He owns no stocks mentioned in this article. Motley Fool writers are investors writing for investors.