To many amateur investors, a company that brings in more than $1 billion in annual sales would seem like a pretty safe bet. But these numbers didn’t impress Wall Street hedge fund manager Whitney Tilson when he noticed them in a report about Lumber Liquidators. From his professional perspective, this small flooring retailer should not have been enjoying such large profit margins. Suspecting that the company was cutting corners in some way, he advised his clients to sell the company short, leading to a decline in its stock price.
Then Tilson received a tip that would soon send Lumber Liquidators’ share price into free fall. Six months after he predicted the stock would tumble, an insider told Tilson about the potentially dangerous ways the company saved money in its Chinese factories. According to this whistleblower, Lumber Liquidators regularly purchased laminate flooring that had been tainted with poisonous amounts of formaldehyde. Using this cheap material reduced costs by as much as 10 percent, a huge gain within the tight margins of the flooring business. All this information eventually came into the public eye after a scathing 60 Minutes report used hidden camera footage to prove that Lumber Liquidators’ suppliers were using tainted materials.
The company’s stock price plummeted by more than 40 percent after the expose aired, immediately sending the flooring retailer on the defensive. Lumber Liquidators released statements decrying the testing methods of 60 Minutes while also accusing short sellers like Tilson of unfairly targeting the company. Short selling stocks can indeed be a controversial practice, since investors are betting on a stock going down in price. In this case, however, Tilson and his colleagues used short selling as a way to shine a light on a pressing health issues as well as to make money. The Consumer Product Safety Commission is currently investigating Lumber Liquidators for malfeasance, which could potentially lead to a multi-billion dollar recall for the flooring company.
- What could happen to Lumber Liquidators if these charges prove true?
- Why is short selling considered a controversial practice in today’s market?
Source: Anderson Cooper, “Lumber Liquidators Linked to Health and Safety Violations,” 60 Minutes, March 1, 2015; Rachel Abrams, “Lumber Liquidators Faces U.S. Safety Inquiry,” The New York Times, March 25, 2015. Photo by: Aonghas Tree.