On Wednesday, Dynatronics (NASDAQ:DYNT), a small medical device company, issued a press release announcing a one-for-five reverse stock split. Most investors and traders who saw this headline on their news stream likely did not even bother to click on the article for details. Those few who parsed the details within the press release, however, would discover that Dynatronics' business is apparently going gangbusters, and the Chairman and President intimated that the company is on track to report a blowout quarter.
As this information started circulating among trading desks, interest slowly picked up in the shares, and the stock closed with 15x average daily volume. I believe this represents the very early stages of a major run, as I expect both value investors and speculative money to pile into this stock in the near-term ahead of this earnings catalyst.
Breakout Quarter Straight Ahead
The management of Dynatronics addresses several interesting corporate developments in the "reverse split" press release. Among these include the opening of a new West Coast facility to enhance operating efficiency. The president reveals that the SolarisPlus line of therapy devices is being well received by the market. He also mentions that the company is working to expand its distribution channels and will introduce a record number of new products next year, which will, and I quote, "lead us to higher profits in the coming year." This all leads to the jewel of the press release:
October was a very profitable month for the Company and should result in earnings for the quarter ended December 31st improving significantly over the same period last year.
So there you have it, in a seemingly trivial reverse split announcement, the Chairman and President of the company telling shareholders that the company is going to knock the cover off the ball.
Analysis of the Reverse Split
According to Dynatronics, the primary motivation of issuing a reverse split is to retain the company's listing on the NASDAQ (delisting to the bulletin boards almost invariably leads to a depressed share price). However, a significant additional advantage exists that should not be overlooked. By definition, a reverse split means that the company has fewer outstanding shares. As discussed above, per management comments, we can expect Dynatronics to have a profitable quarter and strong year. As there are fewer shares outstanding, the profit gets "spread" around to fewer shares, resulting in a much higher headline earnings number, and exceptionally favorable year-over-year comps.
One could argue that this is just optics/financial engineering. Regardless, astute and experienced investors and traders are fully aware that the market reacts favorably (at least initially) to such impressive comps, leading to higher share prices, regardless of the mechanics involved. As such, it is prudent to buy aggressively ahead of this catalyst.
Some have a misguided and outdated notion that a reverse split is a detriment to the share price of a company. On the contrary, reverse splits have actually been a precursor to sharply higher prices. CNBC released a study proclaiming that reverse splits are generally good for investors with respect to large caps in recent years. And this is particularly true in recent months among small cap stocks. Witness the meteoric rise in shares of CombiMatrix (NASDAQ:CBMX), surging 350% on a press release issued almost immediately following a reverse split. This week, B.O.S. Better Online Solutions (NASDAQ:BOSC) skyrocketed 200% following a reverse split, with no other apparent catalyst.
Insiders: Confident Words and Strong Hands
The actions of management are consistent with the bullish forecast of the company discussed above. Over one-third of Dynatronics' stocks are held by insiders, who have not sold any shares for years. In stark contrast to so many other biotechs, the company does not dilute its shareholders by regularly accessing the capital markets.
Even though I believe Dynatronics represents a high probability investment from these levels, the company naturally has similar risks inherent in all small cap, speculative stocks. Also, until resolution, the fiscal cliff adds an additional element of uncertainty.
A major breakout quarter is on the imminent horizon for Dynatronics, which I expect to serve as a major catalyst in the days and weeks ahead. Shares in the hands of dedicated management, a well-timed reverse split, and an impressively bullish forecast should help to drive the momentum forward in the shares of DYNT. As a result, I expect shares to follow a similar trajectory as the shares of Better Solutions and CombiMatrix (CBMX) during their respective runs.
Disclosure: I am long DYNT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.