If you see that a biotech or pharmaceuticals stock is way up — say over 200 percent — without any news to justify the move, look to see if the stock went through a reverse stock split.
This is a move by which company directors reduce its total number of shares outstanding and shares available for trade. Additionally, the stock price is multiplied by some specified factor, thus accounting for the big gain.
For example, if you owned 100 shares of a stock that conducted a one-for-five reverse stock split, you would end up with 20 shares of the stock, but the price from the previous day’s close — when you owned more shares — would be multiplied by five. The result is that the market value of your position remains the same when the reverse stock split is completed.
Reverse stock splits can raise red flags when you’re trading biotech or pharmaceutical stocks.
When a stock is listed on national exchanges such as the New York Stock Exchange and NASDAQ, there are stringent requirements to remain listed. If a company does not meet those requirements, it risks being delisted — pushed off the big exchange to something like the OTC Bulletin Board — which is bad news for shareholders.
Thus, if you see a history of reverse stock splits in a company’s past — something you should be looking for during your due diligence — it could be an indication that the company’s treatments had unfavorable data for some of its pivotal clinical trial data or earnings. Consequently, those events may have caused the stock to sell off, pushing the company to the brink of delisting, forcing management to use a reverse split.
Here’s an example of a biotech company that issued a reverse stock split.
Tonix Pharmaceuticals announced a 1-for-10 reverse stock split, in an attempt to get the company back above the Nasdaq exchange requirements. Here’s a snippet of the company’s press release.
Tonix only began trading in 2012, but this was its second reverse stock splits; it went 1-for-20 with a reverse split in 2013.
If you were analyzing Tonix Pharmaceuticals and noticed this, you might want to conduct further research into how the stock performed and why it had two drastic sell-offs.
A history of reverse stock splits could be an indication of a biotech or pharmaceutical company’s weakness, and automatically raises a red flag. If you notice a stock has issued multiple reverse stock splits, it could signal that the company’s drug pipeline is not robust which could make it subject to further potential sell-offs.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.