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How Low Is Too Low?

When a stock dips below $5 a share, investors may shy away from once sought-after companies. Gateway is one company that found it doesn't have to stay that way.
Kara Newman, Thomson Financial
December 11, 2003

Conventional wisdom holds that institutional investors, particularly mutual funds, automatically unload all holdings of stocks trading below $5 a share. As a result, finance executives may worry that wholesale institutional selling could put further pressure on a teetering share price. If a stock lingers too long at that level, sell-side analysts may drop their coverage, making it even harder bring a company to investors' attention.

Although it's true that many institutions will not hold stocks trading below $5 a share, this is not universal. Many investors regard a good-quality company trading at a low share price as a buying opportunity. For the company, the trick is to stay on the radar screen of the appropriate investors and to keep the communication flowing. This can be a rough task, of course, when staffing is tight and resources in the investor-relations department are already stretched to the limit.

Why Is the $5 Level Important?
Although it might seem arbitrary, investors consider the $5 level important for several very specific reasons:

Communication Is Key
Poway, California-based computer technology company Gateway Inc. has traded on both sides of the $5-a-share marker during the past two years. While many companies cope with a sub-$5 situation by using reverse stock splits or share buybacks to help prop up a sagging share price, Marlys Johnson, who is in charge of investor relations for Gateway, notes the single most important action an investor-relations professional can take: "Communication, communication, communication."

"Whether it's cost-cutting scenarios, or new product introductions, or whatever good news you've got to tell, get out there and tell it," explains Johnson. The more "good news" investors hear from investor relations, she says, the better you can counteract potentially poisonous negativity from short-sellers or hedge funds that can help depress the stock price further.

Gateway's quest to maintain current shareholders while attracting new ones is complicated by the fact that the makeup of investors see-saws depending on the delicate balance of the share price. Value investors may pile into the stock when the price dips below $5, but when the price heads north again, many value investors bail out, putting their profits into another "value play" company. Meanwhile, growth investors will take over when the stock buoys higher, but may lose interest if the stock descends.

For this reason, Johnson encourages IR professionals to review their list of current shareholders and consider targeting new investors, and to tailor that list according to stock price and company strategy. "If you are below $5, maybe you should look at value investors, see if your company matches their criteria and target them. Then as you start to grow and get some traction, go to the GARP ["growth at a reasonable price"] and maybe the growth investors."

Gateway also found unexpected dividends to trading below $5 a share: "Because our market cap went below the qualifications for the Russell 1000," says Johnson, "we entered the Russell 2000," an index closely followed by a number of active and index-oriented institutional investors. "So there was a little more liquidity in the stock, and that was basically because we traded below $5." A lower price, she adds, also makes the stock more attractive to individual investors.

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