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Herbalife Will Only Go Lower

This week it came to light that hedge fund guru Bill Ackman staked out a bearish position in nutrition company Herbalife (NYSE:HLF) several months ago. Shares are off roughly 20% since Tuesday as a result.

So will Herbalife stock bounce back after this gut-wrenching drop, or is the weight-loss shake maker doomed to waste away?

Unfortunately, the diagnosis is quite grim in the short term. Many investors and analysts have been asking hard questions about whether Herbalife is a pyramid scheme and how “real” its sales are, and that kind of uncertainty coupled with big-time selling pressure has created an almost insurmountable headwind for the stock in the near term.

Vulture investors may be tempted to bargain hunt here — and there is a chance that could pay off long-term. However, it remains unlikely that we’ve seen the bottom yet in Herbalife stock.

Those who have been following Herbalife stock should be painfully aware that this is just the latest in a long line of hard questions about the company’s operations — most of which emerged last spring when HLF peaked at $73 a share, roughly double the current pricing:

  • At the beginning of May, another short-side heavyweight sent shares tumbling 20% despite an otherwise rosy earnings call. Hedge fund manager David Einhorn of Greenlight Capital joined the company’s conference call and asked what some characterized as basic questions about the company — resulting in a 20% crash in shares. Einhorn correctly predicted the breakdown of one-time momentum darling Green Mountain Coffee (NASDAQ:GMCR) in the last year.
  • CNBC stock junkie Herb Greenberg shared his own concerns in May — notably about the “distributor” model where salespeople recruit more salespeople, which has been characterized by some as a pyramid scheme.
  • Herbalife CEO Michael Johnson is among the highest paid CEOs in the country, with 2011 compensation that approached $90 million.
  • Ackman’s short position didn’t come out of nowhere. The reports first broken by Kate Kelly of CNBC indicate Ackman’s short position is some “seven or eight months” old. Hardly smacks of market manipulation around options expiration or year-end window dressing if the position is that old.
  • Oh yeah, and those claims of the company being a pyramid scheme? A European court agreed a year ago. That’s a judicial decision in a public court, not a greedy hedge fund manager making overtures to move a stock.

Now, it’s worth noting that, on the surface, the company is booming. Herbalife stock is still up over 400% from its recession-era lows despite the crash and burn in 2012. That’s because revenue went from $2.3 billion in fiscal 2009 to pace over $4 billion this year. Profits have soared too, from an EPS of $1.61 in 2009 to a pace of over $4 in fiscal 2012. Throw in roughly 3% dividend yield after the sell-off and this is a stock with powerful numbers.

However, it’s sentiment driving the Herbalife movement right now and not the data. Investors just can’t trust the numbers they see and are afraid that the near-term momentum is too much to overcome.

They’re probably right.

I’ll be looking into the company extensively over the next several weeks to see whether it’s worth a bargain buy in Q1 of 2013. But the wise move right now is to sit out the bloodbath and wait for the rest of the bad news needs to be digested.

Remember, this kind of crash-and-burn doesn’t have to be tied to something as unscrupulous as creative accounting with a pyramid scheme. Remember Green Mountain, which simply saw its momentum slow and stop? Or Chipotle (NYSE:CMG) — another Einhorn short that proved right as the stock ran out of gas.

The short-selling crowd get a bad rap as market manipulators. But the fact of the matter is that sometimes a shrewd investor can strike it rich by calling a top in a company seeing its parabolic growth rate cool off — and that kind of counterpoint is a crucial part of how the market works.

It just so happens that right now, the market is working against HLF — big time.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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