Pennies from hell
More than 10% of the stocks in the S&P 500 trade for less than $5. And with the market continuing to fall, more big-name firms could hit 'penny stock' status.
NEW YORK (CNNMoney.com) -- All you need is a dollar and a dream. That used to be one of the slogans for the New York State lottery.
Today, you could say the same thing about buying Citigroup stock. Shares of the quasi-nationalized bank closed at just $1.02 Thursday. And if you are investing in Citi (C, Fortune 500) now with the hopes that its fortunes may soon improve, you clearly are dreaming.
Citi is not alone. There are many other brand-name companies trading in so-called "penny stock" status, a term typically used to describe firms with a share price below $5. And more and more companies are joining this dubious group by the day.
I took a look at well-known penny stocks back in mid-November. At that time, 27 of the companies in the S&P 500 had a share price below $5. Through Thursday's close, that number has grown to 51.
What's more, thirteen of those stocks are worth less than what the annoying paper boy asked for in "Better Off Dead" - Two dollars!
In addition to Citi, shares of AIG (AIG, Fortune 500), GM (GM, Fortune 500), Ford Motor (F, Fortune 500) and Fifth Third Bancorp (FITB, Fortune 500) also cost less than a bottle of Two Buck Chuck from Trader Joe's.
And if the market keeps heading south, even more S&P 500 companies may wind up trading below $5. There are currently 64 other components of the index with a stock price between $5 and $10.
It's not just companies in this key market benchmark that are trading at such low levels either. Widely held and well-known stocks such as Delta (DAL, Fortune 500), Wendy's/Arby's (WEN) and 3Com (COMS) are below $5.
And the shares of many prominent foreign companies listed in the U.S. - including British bank Barclays (BCS), French telecom equipment firm Alcatel-Lucent (ALU) and Chinese computer maker Lenovo (LNVGY) - can also be bought at this discounted price.
So what's the significance of this? Falling below $5 can often feel like a death sentence for a stock. That's because some mutual funds and other institutional investors like pension funds have explicit rules in their charters that prohibit them from owning stocks with a price lower than $5.
And if big money managers are forced to sell, that has the potential to create a massive flight for the exits by other investors. You can argue that's exactly what is happening with Citi, Bank of America (BAC, Fortune 500) and other troubled banks.
It doesn't help that many of these sub-$5 stocks are also cutting, or in some cases even eliminating, their dividends. Doing that, while probably a prudent use of capital, may also cause equity-income mutual funds that can only own stocks with a decent dividend yield to dump shares as well.
But one thing has changed since my November column that could offer some of the worst-performing stocks a temporary reprieve. The New York Stock Exchange announced last week that it was temporarily suspending its $1 minimum price requirement until June 30.
Previously, if a company had an average stock price below $1 for a 30-day trading period, the company would face the risk of having its stock delisted by the NYSE.
This may give some low-priced stocks some breathing room and keep companies from announcing so-called reverse stock splits, which allow a firm to artificially increase its share price by reducing the number of its total shares outstanding.
The problem with reverse splits is that they are merely psychological boosts, since the value of the company does not change. If you own 500 shares of a company trading at $1 and that company performs a 1-for-5 split, you'd be left with 100 shares at $5 apiece. In other words, the investment is still worth $500.
Preventing a wave of reverse splits could be good news since, as I pointed out in the November column, these splits rarely work. Companies often wind up pumping their stock above $5 with a split only to have the share price quickly fall back below it again.
Of course, this is not to say that all stocks trading below $5 are doomed for failure.
A quick look at the companies on this ignominious list shows that for every Citi and GM, money-losing firms with highly uncertain futures, there are also some proverbial babies thrown out with the bath water, such as CBS (CBS, Fortune 500) and Xerox (XRX, Fortune 500). Those two companies are in slow-growth businesses to be sure. But each was profitable last year and are expected to remain in the black this year.
Still, it's tough for a company to claw its way back above $5. They say that investors hate uncertainty. But what they hate even more are stocks that have been left for dead. Nobody wants to be the brave soul to say that a stock trading even as low as a $1 is a bargain when it looks like zero isn't out of the question. 
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