The battle in Herbalife (NYSE:HLF) stock continues as the company has defended itself in its investors and analyst meetings. Recently Dan Loeb disclosed that they own 8% of the stock in the company, the SEC has started an inquiry on the company and Bill Ackman is expected to issue a rebuttal to the counter-arguments people have put forward against his short thesis.
It's very important for investors to realize that betting on Herbalife one way or the other is a extremely risky game for a number of reasons, let me list them:
-As a short it is risky because Herbalife PEG ratio is 0.61. Yes if the FTC were to take enforcement action or if they were forced to disclose success rates for distributors lots of the earnings of the company and its growth could evaporate overnight but while that doesn't happen a low PEG ratio will attract "value" investors like moths are attracted to flames. In fact this was one of the very reasons that Dan Loeb decided to invest in the company:
"Let's not forget: the business itself is performing well. Volume, revenue and earnings are all growing double digits and the balance sheet is largely unlevered," Loeb said. "…Applying a modest 10-12x earnings multiple suggests Herbalife's shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point."
He could be the first of many. Even Carl Icahn is rumored to be buying the stock (and he has personal issues with Bill Ackman due a past lawsuit).
-The stock 30 day standard deviation is $6.84 or 17%. Compared to [[SPY]]'s 1.4%. This stock is super volatile and it's likely to lead you to doubt your own position. You might cover and sell just at the worst moment.
-The stock is volatile as a result of a headline casino game that is being play by daytraders and hedge funds. Let's say you are long and see an intraday large drop on big volume, what does that mean? Maybe the FTC has initiated an investigation, maybe it's a HFT flash crash, maybe Ackman is putting comments. Should you sell? You have no way of reacting properly until you get the news and the pros get the news first because they have expensive Bloomberg Terminals. Without that you will be reacting to news after they all do.
-Investing in the stock one way or the other requires knowledge of law, FTC rules, historical lawsuits and international pyramid laws. I find it amusing how many people all of the sudden are experts on these matters. I bet they are all learning on the fly and this puts you at a significant disadvantage to better informed investors who can afford expensive and deep research, along with increasing that chance you will make a significant error in a extremely volatile stock (which will be more costly than usual). And with a 17% standard deviation you can be pretty darn sure that stock will go against you big time at some point, if you don't trust your views due lack of expertise you are likely to get shaken out and close out at a loss.
-Lastly, there are easier plays than this. As Buffett says the advantage of investing is that you can wait for the right pitch unlike in baseball where you have only 3 strikes. In a complex situation where there could be headline manipulation and difficult legal matters in place it's better to wait for a better pitch in 99% of cases. If you are an expert go ahead and bet but most are not.
We have no bias on the stock and find the situation difficult to predict given that it is not easy to put a probability in the chance of a FTC enforcement action. It is not easy to predict the global consequences of negative actions taken in the US either. As a result we believe betting in the stock one way or the other without access to better, faster and high quality information is a like gambling in a casino. We believe that there are superior ways of putting capital to work.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.