Such low valuations sap employee morale and practically rule out the possibility of acquiring other companies as a way to grow. In addition, once a stock dips below $5, it also slips beneath the radar screens of institutional investors and analysts.
As a result, many companies in this category will find it even more difficult to climb out of the single digits, portfolio managers and analysts say.
The lack of visibility is a concern for scores of Net companies. Of the 665 companies in 18 tech sectors tracked by CNET News.com, 78, or nearly 12 percent, were recently trading below $5 per share. Internet retailers had the highest ratio of companies trading below $5: 11 of 27, or 41 percent.
The list includes well-known companies such as Autoweb, Value America and Peapod. In some cases, these companies are trading 80 percent below their 52-week highs.
Peapod, which is trading around $3, is struggling with the sub-$5 blues.
The online grocer, with a market capitalization of about $50 million, has seen the number of analysts covering it fall to four from eight since it went public in 1997. Meanwhile, three of the four analysts who follow the company recently cut their recommendations to "neutral" from "buy," as the cash-strapped company has struggled to secure financing after its CEO resigned.
"I can see how our stock price has affected our analyst coverage," said Dan Rabinowitz, Peapod's chief financial officer. "Analysts, as a group, will cover a stock if they can get some banking business from the company or trading business from their clients, or if they can get any of these two from the company's competitors for following the sector."
Analysts have less interest in initiating coverage on a company when it trades in the single digits, said Andrea Williams Rice, an Internet analyst with Deutsche Banc Alex Brown.
"It takes more work to get the sales force and investors interested in the company," Williams Rice said. "In reality, analysts spend time where there's investor interest. If it's a $3 stock, then sometimes it's not worth the effort."
She noted, however, that if an analyst believes a company's fundamental business is strong, he or she will still maintain coverage.
"One of the worst things an analyst can do is hide. If the stock gets weak, you still need to talk about it," Williams Rice said. "Even if investors don't want to listen, it's your job to keep them informed if you think the stock is attractive."
Some mutual funds are prohibited from investing in stocks that trade under $5, while others can invest only in companies with a certain market capitalization size, said Bruce Lupatkin, who runs technology hedge fund North Bay Technology Partners.
More importantly, funds look to invest in companies that will have a meaningful effect on an overall portfolio. It takes far more shares at $5 each to contribute to the performance of a billion-dollar fund than it does with a $50 stock.
Lupatkin said, "I think a stock trading in the single digits can be the kiss of death."
Doug Baird, co-head of U.S. equity capital markets for Deutsche Banc Alex Brown, noted that a company's market capitalization is also important. The market value is derived by taking a company's stock price and multiplying it by the number of outstanding shares.
Companies with low market values often find it difficult to access the capital markets when looking for funding, Baird said.