The lessons from Herbalife & Why “Ugly” Stocks Can Be the Most Attractive Investments

Guest Post by Investment Contrarians

Sometimes something that is viewed as ugly by one person is absolute beauty in someone else’s eyes. This is what the phrase “beauty is in the eye of the beholder” represents. 

The same argument can be used in analyzing stocks. For instance, when I examine stocks, I will look at companies that are considered the dogs of Wall Street. These stocks generally are characterized by significant short selling, which means the market is betting against them. 

Yet as the phrase suggests, there are stocks that are in the dumpster but have great upside potential for those who see the positives in the stock and have an appetite for risk. If they are right about the positive outcome, they can make some good profits. 

A perfect case of this is with nutritional products company Herbalife Ltd. (NYSE/HLF). Hedge fund manager Bill Ackman simply hated the look of Herbalife and suggested the company is a pyramid scheme. 

Ackman took out a large short selling position on Herbalife hoping to cash in on his perception of the company’s ugliness. 

Then in comes investment guru George Soros who has made tons of money in his life. Unlike Ackman, Soros saw the beauty of Herbalife, and so he added a position. 

I’m not sure if Ackman has been covering his short selling in Herbalife, but if he hasn’t, he will lose tons of money. As the chart below clearly indicates, if he did not cover his short selling, there are probably many unhappy investors in his fund. 

Take a look at the chart below of Herbalife. Note that the stock plummeted in December 2012 to just above $25.00. Since then, the stock has made a steady climb to above $65.00, up 160%

Chart courtesy of www.StockCharts.com 

As of July 15, there were 30.21 million shares shorted, or a massive 43.0% of the float, according to Thomson Financial. A month ago, there were 31.97 million shorted shares, so there has been some covering of short selling in the month. 

The thing is that Herbalife is not an isolated situation. There are numerous companies with heavy short selling positions that may look better to your eyes. Groupon, Inc. (NASDAQ/GRPN) was a heavily short selling stock that I discussed earlier in the year. It was ugly in the eyes of many, but I thought that it might be worth a second look. The stock is up 238% since November 2012—and that’s a thing of beauty, if you ask me. 

~ by George Leong, B.Comm.

This article was originally published at Investment Contrarians