This week we heard substantial news about a controversial stock: Herbalife (HLF) passed its audit, with PwC dismissing any concerns about fraud around the company. The stock rose over 4 points immediately on the news, and had a couple of strong days as a result.
More buyers into a name on good news is not surprising, but there’s an interesting story behind this particular name at this particular time. While we see the ticker go green, we can categorize three groups of buyers who have very different motivators in pouring into this name at this particular moment.
1. Long Investors
Firstly and most obviously, those investors who believe in the growth story behind this name could breathe a sigh of relief after HLF cleared its audit and no signs of wrongdoing were discovered. This provided an opportunity to grow stakes in the name. In addition to hedge funds making long bets on the company, there are also retail investors and institutional investors who have allocations of HLF as a growth stock with potential for a higher P/E ratio. Even after the rise, the stock’s P/E is below 16 but the company’s growth is in the double digits. That means it’s more of a growth stock and thus it should have a P/E above 20—arguably it would if Bill Ackman and other short sellers hadn’t accused the company of fraud. With a clear audit, there’s reason to expect the company’s P/E ratio to rise to growth stock levels.
2. Short Coverers
Speaking of shorts, Ackman’s fund isn’t the only group who has shorted the stock. A number of investors big and small have followed Ackman in shorting the stock on a bet that the company will be exposed as a pyramid scheme or accounting irregularities will appear.
Ackman has said he will bet against HLF to the ends of the Earth. Others might not have that high of a conviction, and others still might face a margin call on that short. A spike in the price signaled too many short sellers that they need to cover this bet, and that demand for the stock put sellers in a strong position to help those shorters out for a price. Which brings us to our third group.
3. Traders Offering Liquidity
Daytraders both in institutions and at the retail level have seen the potential in selling HLF to short coverers (of course, there are also traders who have seen the potential in short-term shorting of the name to provide liquidity to investors going the other way). With the news of PwC’s positive review, traders pounded into the name to ride the wave. These traders looked closely at the price action to go long at the right time and short at the right time, profiting on the very fast waves in price that inevitably resulted in groups one and two looking more intensely at the name.
(Almost) Everyone Makes Money
Each of these three groups, in their own way and for different reasons, were using the rise in HLF’s price to make a profit. Even the short coverers were profiting, in a way—by cutting their losses today, they were saving themselves from expected losses further down the line.
The price action wasn’t profitable for everyone, of course. Some daytraders entered and exited at the wrong time, thereby losing money in the process. Some got too greedy and took on too much risk for too little reward. And, of course, the stubborn shorters who insist that the company will be exposed someday took big losses in the aftermath of the audit. In the future, long investors might find themselves taking a big loss as the company is exposed to be a fraud. But for now, HLF provided them a tidy profit and the conclusion in this one battle was decisively won in their favor.