This Broken Stock Could Break Further


Stocks recovered from early losses; the Dow Jones Industrial Average and the S&P 500 gained 0.5% and 0.6% today, respectively.

The micro view
Tim-ber! After yesterday's 12% decline of Herbalife shares in anticipation of hedge fund manager Bill Ackman's "short" presentation, the stock fell almost 10% today. Relative to their 52-week week high achieved in April, the shares have lost more than half their value.

Without having spent a single minute analyzing the company or the stock, I would urge current Herbalife investors -- particularly those who consider themselves long-term ones -- to review their holding with an extremely skeptical attitude. Why? Two simple elements:

  • CEO Reaction: When he took to CNBC's airwaves on Wednesday, Herbalife CEO Michael Johnson immediately called for the SEC to investigate what he called "blatant market manipulation." That's a classic attempt at misdirection, which is characteristic of managers of scam companies in response to short-sellers.

The truth, to quote legendary value investor Seth Klarman, "is that short-sellers do far better analysis than long buyers because they have to." Ackman, who manages Pershing Square Capital Management, is a superb fundamental analyst and investor -- he is smart and extremely thorough. If he says there's something wrong with a business, it's well worth listening to his reasoning.

  • CEO Pay: The Financial Times reports that Herbalife paid Mr. Johnson $89 million in total compensation last year, making him the highest-paid CEO in corporate America, according to GMI ratings. Let's put that number in context: It represents nearly 2% of Herbalife's $4.5 billion market value prior to Wednesday's decline. It would require a tremendous amount of convincing for me to believe that Mr. Johnson is worth that type of remuneration -- particularly if one considers the company's business model (network marketing.) That suggests to me that Herbalife's corporate governance is severely deficient, and that shareholders should be extremely vigilant in looking out for their own backs. In practice, that means following the company closely, and only investing when you can do so at a substantial margin of safety.

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Alex Dumortier, CFA has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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