The Illusion of the Reverse Split

March 22, 2011 at 12:05 am 1 comment

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I’m still trying to figure it out – do I want more shares and a reduced share price in the case of a traditional stock split, or do I want less shares and an increased share price in the case of a reverse stock split? Well, apparently Citigroup Inc. (C) has determined the latter reverse stock split is the best approach.  Citigroup CEO Vikram Pandit hailed the reverse split and $0.01 dividend announcement in a broadly distributed press release, as if these irrelevant illusions were transformative:

“Citi is a fundamentally different company than it was three years ago. The reverse stock split and intention to reinstate a dividend are important steps as we anticipate returning capital to shareholders starting next year.”

 

Okay, so Citigroup is paying out a whopping 1/10 of one penny per your current share price (compared to $.49 per share before the financial crisis) and Vikram is telling me I should be excited. Maybe additional ecstasy should be kicking in once shareholders learn they will receive 1 pie with no slices, rather than 1 pie with 10 slices? These same share-slicing and re-piecing gimmicks were implemented in the pre and post dot-com era with no beneficial value. If this truly was such a novel idea, I wonder why smart people like Warren Buffett have chosen not put such amazing, whiz-bang ideas to use. The lauded 1-10 reverse split planned by Citigroup could also be used to raise Berkshire Hathaway’s share price from $127,766 per share to $1,277,660 per share. One share of post reverse-split BRKA could buy you 288,410 shares of Citigroup today.

Proponents of the reverse split cite the institutional benefits provided by the move. Not only will institutions previously prohibited from buying single digit equity securities now be able to buy Citigroup shares, but institutions will also be able to pay lower commissions because the current 29 billion shares outstanding will be reduced to a measly 2,900,000,000 shares. In reality, reducing share count through a reverse split may fool a few unknowledgeable speculators, but prudent investors understand a reverse split does not impact the value of the company one iota.

The fact of the matter is that earnings and cash flow growth will be the main drivers behind institutional shareholder buying of Citigroup’s stock.

Famous investor John Templeton simply stated, “In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.”

Peter Lynch appreciated the importance of earnings too: “People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”

So while Citigroup may not be a horrible stock, the announcing of a 1 for 10 reverse stock split will not be a share price savior. So rather than let the illusion of capital structure gimmicks inform your decisions, investors would be better served by focusing on the sustainability and growth of earnings and cash flows.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BRKA/B, C, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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Entry filed under: Education, Stocks. Tags: , , , , .

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