What are reverse splits?
A reverse stock split is the opposite of a straight split: For example, in a 1-for-5 reverse split, an investor with 100 shares worth $3 each will end up with 10 shares at $30. In any case, the value stays at $1,000.
While a split itself doesn't change the market value of a company, it is seen as a signal about its prospects. The market typically interprets a straight split as bullish and a reverse split as bearish, Johnson said.
Reverse splits are "a last ditch effort" to boost a share price when the company's own business cannot under present market conditions, he added. However, "in most cases, it doesn't work."
Companies do reverse splits to boost their stock price, at least in the short run, and stave off a possible delisting. Higher prices lure institutional investors, who typically stay away from cheap stocks with low liquidity - the pool of shares isn't large enough for big investors to easily trade holdings without causing major movements.
Johnson said the cut off price for institutional investors like mutual funds had been $12 to $15, but it's down to $7 to $8 in the bear market
A reverse split also shrinks the number of shares traded, decreasing dilution for companies that have had too many straight splits.
While AT&T is not in danger of being delisted -- trading well above the $1 minimum required by the New York Stock Exchange --analysts believe most of the stock's value lies in its cable assets, which is being sold to Comcast (CMCSK: news, chart, profile). After the sale, the fear is that AT&T might dive. Shareholders approved a 1-for 5 in July; the Comcast deal is expected to close by the end of the year.
Johnson believes that large-cap companies that do reverse splits generally have a better shot at succeeding than small firms.
Still, Marc Gerstein, director of investment research at Multex, advises investors to stay away from them.
"If I had a company that announced a reverse split, I'd sell it," he said. "I'd rather see them improve operations" to boost the stock.
Some companies even do more than one reverse split, which Gerstein sees as a true sign of desperation. This year, four companies undertook at least two splits: Timber (TBRR: news, chart, profile), Knowledge Networks (KNWK: news, chart, profile), Career Worth (CRWO: news, chart, profile) and Midwest Venture (MVHI: news, chart, profile).
As a result of a 1-for-100 split and a 1-for-250 split, Timber's loss per share ballooned past three digits since the number of shares has shrunk greatly - and too big to fit into Multex's database.
Knowledge Networks has had three reverse splits. "It has no present business or productive assets," Gerstein said. "Enough said."
Career Worth used to sell job listings on CD-ROM, but the Internet foiled its business. It's trying to get into the construction industry.
"In the first half of 2001, I had more cash in my checking account than they had in sales," Gerstein said. "That's frightening."
As for Midwest, Multex describes it as a "development stage company" that "intends to engage in the business of acquiring and developing property." It has no sales but lost $2 million in the first six months of 2002 due to higher general and administrative costs.
"I think I saw this in the Sopranos," Gerstein said. "These are companies you don't want to be owning."
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