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When a firm downgrades a stock after being one of the lead underwriters of the offering, you’re looking at about as clear a sell signal as you can find. That is what happened to Lumber Liquidators (NYSE:LL) when Goldman Sachs downgraded the hardwood flooring retailer from a buy to a hold, saying that, after the stock’s recent run, LL’s share “trade at one of the highest multiples in [our] coverage universe.

Even more disconcerting: a private equity company that invested in LL three years prior to the IPO has been selling millions of dollars worth of LL shares in the past few weeks, according to SEC filings.

Lumber Liquidator’s recent price run is worth examining. In fact there are so many facets to it that I will have to make this part one of a two part series with part two detailing how the remodeling business fits in to the larger housing/credit picture and explain why Lumber Liqudiators will have a difficult time sustaining its growth in the next year.

At first glance it would appear that their stock sustained an impressive run while housing stocks fell off a cliff. What many people forget, however, is that housing and home improvement stocks staged a huge rally earlier this year, with many homebuilders booking 50-80% gains in the first four months of this year. It was only during this rally that LL’s stock showed impressive performance. Like other housing stocks in general, more recently it has begun to roll back.

There could be another factor in the height of Lumber Liquidator’s climb. This is only my speculation, but Lumber Liquidator’s stock may have been bought up (and brought up) mainly by traders seeking to ride the stock’s appearance in Investor’s Business Daily.

The Daily is perhaps best known for its IBD 100, a weekend listing of what the paper’s proprietary scoring system rank as the current 100 strongest stocks .

Why does the IBD 100 matter so much? Simply put, it frequently gives stocks a bump that can be greater than even the “Cramer bump” (the price jump a stock normally enjoys when Jim Cramer mentions it on his CNBC TV show, Mad Money) – although the IBD boost is not as obvious because its effect is realized over a longer time.

Some stocks, however, have doubled in price largely because of the attention they received from IBD. With that kind of potential reward hanging out there, some traders may bid a stock up before the paper’s weekend edition, in hopes it may reach or stay on the coveted list.

That game is made possible by two facts: First, IBD will only include a stock on its 100 lists if it is trading at $15 a share or more. Second, IBD every Thursday also publishes a list of their top 200 stocks, but without the $15 dollar/share requirement.

This appears to have been one factor in Lumber Liquidators’ recent price performance. LL has been the subject of trader chatter since the end of April, when its earnings announcement showed eps growth high enough to be considered for the IBD 100. The earnings announcement wasn’t impressive enough for the street as a whole, as the stock posted three straight days of losses following the release of earnings . But the stock then began to rise, as some traders, apparently, bought in anticipation of an IBD debut. They were rewarded when, a few weeks ago, the stock’s appearance on the IBD 100 helped to push shares up to $18. After falling earlier last Friday, LL mysteriously rebounded to almost exactly $15 a share, closed at $15.09.

The catch in this game is that people who follow Investors Business Daily also tend to follow the paper’s rules for trading and investment, one of which is to cut losses quickly when you are down on a position. When an IBD stock loses momentum it can lose it quickly, as a chain reaction of loss-cutting takes place. If a stock cannot stay above $15 and is therefore dropped from list it, can decline even further as momentum players flee the stock. With the Goldman Sachs downgrade, LL’s ability to tread water at $15 is likely gone and with it it’s ability to stay in the IBD 100.

With the hype surrounding the stock’s begining to fade, with one of its largest holders selling and it's own underwriter issuing a downgrade it is increasingly looking like it may be time to sell Lumber Liquidators.

Disclosure: Author has a short position in LL

 

Source: The Floorboards are Creaking Beneath Lumber Liquidators: Part I