Citigroup's Reverse Split Could Be Toxic For Investors

Citigroup's(C) plan for a reverse split was greeted with a chorus of boos, as investors frowned upon theCheap Rosetta Stone
bailed-out bank's use of a cosmetic change to artificially boost its stagnant share price from $4 to $40. Retail investors at home should jeer Citigroup's decision, too, but for different reasons.

In March, Citigroup announced plans for a 10-for-1 reverse stock split, which will propel the share price to above $40 by reducing the number of outstanding shares from 29 billion to less than 3 billion. Set to take effect May 6, Citigroup CEO Vikram Pandit contends that the reverse split, coupled with the reinstatement of a penny-per-share dividend "are important steps as we anticipate returning capital to shareholders starting next year."

On Monday, Citigroup reported a first-quarter profit of 10 cents a share, coming in a penny ahead of the average analyst estimate. However, Citigroup's $3 billion in net income was padded by a $3.3 billion reserve release in the quarter. Revenue of $19.7 billion also fell short of Wall Street's expectations.

Reverse splits are generally pooh-poohed by professional investors because nothing fundamentally changes with a company, even if retail investors believe the higher share price denotes an increase in quality. The only change is the number of shares outstanding and the price of each share, but value and earnings are not affected by the decision.

The one positive argument to be made for the reverse split is that many mutual funds have charters that restrict portfolio managers from buying stocks that trade below $5. The argument is that, post-split, Citigroup becomes anCheap Rosetta Stone Portuguese
investment candidate for many institutional buyers previously forbidden from owning the bank stock.

However, there are many reasons a reverse split is bad, and not just in Citigroup's case. Aside from appearing to be a move made out of desperation, stocks typically fail to perform well after a reverse split is enacted. According to a 2006 joint study conducted by students at NYU's Stern Business School and Emory's Goizueta Business School, more than 1,600 companies that conducted reverse splits underperformed the broader market by about 50%, on average, in the three years after the split.

Recently, though, companies have shown an ability to thrive with or without a reverse split. Both Priceline.com(PCLN) and troubled insurer American International Group(AIG) have rallied after their respective reverse splits.

Meanwhile, Sirius XM(SIRI), for which shareholders approved a reverse split after the satellite-radio company flirted with bankruptcy and possible delisting, has seen its stock price roar back by 1,000%. In Sirius XM's most recent shareholder proxy, a call for Cheap Rosetta Stone Spanish
a reverse split was notably absent, leading investors to believe it is officially off the table now.