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Some companies go through a share consolidation to be able to list on the New York Stock Exchange and gain more investors south of the border.

subman/iStockPhoto / Getty Images

Aurora Cannabis Inc. (ACB-T) did a 1-for-12 reverse stock split this year. Sprott Inc. (SII-T) completed a 1-for-10 share consolidation. And Hexo Corp. (HEXO-T) may do the same to comply with the New York Stock Exchange’s (NYSE) listing standards.

Although a share rollback can raise a red flag about a company’s fortunes, it can also be worthwhile for investors to dig deeper into the reason for this move and the outlook for that company’s industry before selling the stock or buying it for a bullish bet.

Unlike recent high-profile stock splits by Apple Inc. (AAPL-Q) and Tesla Inc. (TSLA-Q), which increase the number of shares outstanding at lower prices, a reverse stock split results in fewer and proportionately higher-priced shares.

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“A reverse split [itself] doesn’t change anything – the stock is worth the same and fundamentals remain the same,” says Ryan Modesto, chief executive officer at Waterloo, Ont.-based independent investment research firm 5i Research Inc.

“You have to look under the hood. Is there a strategic shift at the company, or should my thesis change? That’s certainly something to consider,” he says.

The move might occur to adhere to a listing requirement by a U.S. stock exchange – such as stocks needing to trade above US$1 a share – or to spruce up a company’s image to avoid the penny-stock label. Mutual funds or other investors are also not allowed to buy stocks trading below certain minimums.

“Reverse stock splits often come from a bad position,” Mr. Modesto says. “The shares have performed poorly, and what was a $10 share price is maybe 50 cents, and you do a reverse stock split to get that price [back] up.”

But this kind of decision is not a magic bullet, he says. “It doesn’t solve declining revenue, lost contracts or customers, or whatever those issues were. The company still needs to solve those fundamental underlying problems.”

Benjamin Gallander, co-founder and president of Contra the Heard investment newsletter in Toronto, says it’s worth considering the rationale for a share consolidation. However, he typically sells the stock before that event because his research indicates that it’s a bearish signal.

“As a general rule before the consolidation, the stock price goes down,” he says. “After the consolidation, the stock price often goes up 10 to 15 per cent in the short term – and then continues to go down.”

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If investors are interested in the stock, “I would wait for about a year [after the consolidation] before jumping in,” and it could be a better bargain if that timing coincides with tax-loss selling season, says Mr. Gallander, a contrarian investor.

His selling discipline came in handy with shares of oil and gas company Obsidian Energy Inc. (OBE-T), which was held in Contra’s “president’s portfolio.” Mr. Gallander sold the stock at 46 cents a share – or $3.22 postsplit – before the 1-for-7 share consolidation in June, 2019.

Obsidian’s stock kept falling and it now trades in the 50-cent range. “I lost money … but I salvaged a lot more by selling,” he says.

However, Ben Stadelmann, co-founder and vice-president at Contra, and Philip MacKellar, an analyst, hung on to Norsat International Inc. in the “vice-president’s portfolio” after the satellite communications company did a 1-for-10 reverse split in 2015. The Richmond, B.C.-based firm planned to list on the NYSE because most of its sales came from the U.S. market.

Norsat’s Canadian-listed stock, which was purchased at a postsplit equivalent of $6.20 a share, fell under $5 before it was sold at $15.16 a share in 2017 after a takeover battle for the firm, he says. “That was an [profitable] exception, but it does happen.”

Mr. Stadelmann and Mr. MacKellar also held onto Sprott when the precious-metals asset-management firm did a reverse stock split in May to list on the NYSE. The reason for the consolidation was because Sprott has many clients in the United States and it wanted to attract more investors there.

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Mr. Gallander says his colleagues have a bullish view on gold and felt that Sprott had upside potential.

“It has worked out,” he says, referring to the gold price rallying above US$2,000 an ounce before the recent pullback.

On May 27, Sprott’s stock closed at $3.70 a share on the Toronto Stock Exchange with 33,770 shares changing hands. The next day, the postsplit shares closed at $36.19 with volume surging to 291,200 shares. They then hit a 52-week high of more than $57 a share before the recent retreat to the mid $40-range.

Sprott’s higher stock price is more attractive to investors because it now can be viewed as a senior company, says Ron Meisels, president of Montreal-based independent investment research firm Phases & Cycles Inc.

As a result, Sprott’s shares can not only be considered by institutional investors but also by many retail investors because brokerage firms often won’t allow clients to buy stocks below $5 a share unless indicated on their “know your client” form, he says.

However, a share consolidation can also have an ugly ending, Mr. Meisels warns, as in the case of New York-based Helios and Matheson Analytics Inc. (HMNY-OTC), parent of former MoviePass cinema-ticket subscription service.

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The company’s stock, which was listed on the Nasdaq Stock Market, did a 1-to-250 reverse stock split in July, 2018. Its shares traded at US$22.50 postsplit but sank to 22 US cents five days later. It was delisted in 2019 and moved to the over-the-counter market, where it plunged to zero after filing for bankruptcy this year.

An industry sector’s outlook, Mr. Meisels says, can also play a role in how a share consolidation can fare. Calgary-based oil and gas company Encana Corp. did a 1-for-5 reverse stock split in January when it moved its head office to the U.S. and changed its name to Ovintiv Inc. (OVV-T). The strategy was to gain access to a bigger investing audience – specifically, U.S. index funds.

Ovintiv’s Canadian-listed stock jumped to $23 a share from $4.96 presplit, but “that didn’t stop it from falling,” he says. It plunged to $2.95 a share during the market downturn in March before recovering recently to around $12 a share.

Marijuana producer Aurora Cannabis did its reverse stock split in May to remain eligible for trading on the NYSE. Its Canadian stock jumped to about $11 a share postsplit and climbed as high as $24 before pulling back recently to the mid-$6 range.

Besides company-specific woes, Aurora Cannabis and its peer, Hexo, have been hurt by a bear market for cannabis stocks while Ovintiv was hit by a tough energy market, Mr. Meisels says. In contrast, Sprott benefited from a strong gold bull market.

“In a bear market, it doesn’t help if you do a reverse stock split,” he says. “In a bull market, chances are you will have a better outcome – except in the case of a company with a lot of financial problems.”

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