I Predict a Reverse Stock Split Explosion

Your Tiny Smurf Stocks

I’m calling it here and now:  2009 will witness a record-setting explosion in reverse stock splits, on both the New York Stock Exchange and the NASDAQ.

According to Marketwatch.com, more than half of the Wilshire 5000 index is currently trading under $5 per share.  That’s pretty sick when you think about it.  The Wilshire 5000 is made up of the 5000 most prominent stocks across all exchanges.

The fact that HALF of them are under 5 is astounding, and will probably spur the boards of many companies to take action. There are two ways for these companies to fix this problem:  One, they could do better financially…OK, I know, LOL.  Two, they could authorize a reverse split, and despite the company’s actual fundamentals, make their stock look significantly more healthy.

A reverse split is basically a way to boost your share price while lowering the amount of shares you have outstanding.  For example, if you owned, say, 10,000 shares of Bank of America at $4 and they decided to do a 1 for 10 reverse split, you would end up with only 1000 shares, but the stock would be trading at 40 instead of 4.  You still have the same position value of $40,000, but the stock price looks more respectable.

There has always been a negative connotation to the term reverse split, because typically they’ve only been undertaken by small and micro cap stocks.  Notice the disparaging tone in the below definition by Investopedia:

For example, a 1-for-2 reverse split means you get half as many shares, but at twice the price. It’s usually a bad sign if a company is forced to reverse split – firms do it to make their stock look more valuable when, in fact, nothing has changed. A company may also do a reverse split to avoid being delisted.

If companies like B of A would wake up and start reverse splitting already, they could probably attract new investors and retain current, skittish shareholders who feel like they’re aboard a sinking vessel.

Of course, reverse splitting your shares doesn’t have any impact on the health of a company’s balance sheet, but on The Street, perception is of major league importance these days.

Here’s one other benefit to a reverse split.  Let’s use B of A as an example once again.  Let’s just say…and I know I’m talking crazy here…but let’s suppose the company begins to earn money again, even in fractional amounts.  You take an earnings per share number of .004 (4 tenths of a penny), which would normally be interpreted as break-even, and put that through a 1 for 10 reverse split, now you’re talking about earnings per share of 4 cents.  Earnings of 12 cents per share become earnings of $1.20.

Again, we’re talking zero impact on the actual fundamentals, but the name of the game right now is survival for equities and an oak tree-like share price of 40 would scream survival amidst a forest of single digit mushrooms.

The list of stocks that could and should be considering reverse stock splits right now is endless, from retailers to techs to banks (of course).  With proxy season coming up, don’t fall out of your chair if my prediction comes to pass and all the 5’s and 6’s in this market turn into 50’s and 60’s, if only to avoid the sub-$5 stigma.

Full Disclosure:  I have no position in BAC