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Beware Delisting, Reverse Splits


Sign of the Times



 Amy E Buttell The banking crisis and recession are taking their toll on stock prices. Although a rebound in market indexes has brought some relief, several components of major indexes are trading near historic lows (see table, below).

 

Losing money you’ve invested either on your own or through your club is certainly painful. Unfortunately, it isn’t the only issue faced by investors in companies with low stock prices. If shares trade at or below certain levels for too long — typically $1 a share — they may risk delisting by their exchanges, which can pose all sorts of problems.
   
“Theoretically, trading a delisted stock isn’t any different from buying or selling any other stock — an investor just has to place an order with their broker,” says Jonas Elmerraji, portfolio manager and editor of the Rhino Stock Report, an investment advisory letter. “But that’s unfortunately where the similarities end. When companies get delisted, one of the biggest concerns for individual investors is liquidity. Stocks that trade over the counter — not on any exchanges — generally have less buying and selling volume than bigger exchange-traded stocks, and as a result their prices are easier to manipulate.”
   
When a company’s stock is delisted from an exchange, many institutional investors, such as pension funds and mutual funds, may be forced to sell those stocks because of internal rules on minimum price and market capitalization, says Peter Miralles, a financial adviser with Atlanta Wealth Consultants. This reinforces the cycle of less liquidity.
   
Companies with chronically low stock prices can be traps for unwary investors. Low-priced stocks may experience large gains at the beginning of a bull market only because short-sellers need to cover their positions. “That kind of momentum may also attract short-term traders,” Miralles says. “If you buy it after all that and the fundamentals are still bad, there may be a big loss waiting to happen.”
   
Even if a company’s stock price stays above the $1 mark, such low prices are generally unattractive to investors. In such a case, the company may consider a reverse stock split, by which the company will reduce the number of common shares outstanding to raise the stock price. In such a case, investors receive one share of stock for every two they own, for example, which would double the price of the stock and leave half the previous number of shares outstanding.
   
Reverse splits do little for investors, however. “Reverse splits usually signal trouble and do nothing to correct what’s ailing the company,” says Frank Fernandez, the manager of equity trading at J.P. Turner & Company in Atlanta. “It’s a maneuver used to get the stock price over a dollar so the stock doesn’t get delisted, though statistics show that probably three quarters of recently reversed-split stocks trade lower following the split.”


Freelance writer Amy E. Buttell of Erie, Pa., covers mutual funds for BetterInvesting. She’s also the author of the second edition of the association’s Mutual Fund Handbook.


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