16 January 2019
Lumber Liquidators is facing fallout from reports it sold unsafe flooring made in China. The stock is down 25 percent. Photo: Reuters
Lumber Liquidators is facing fallout from reports it sold unsafe flooring made in China. The stock is down 25 percent. Photo: Reuters

What Lumber Liquidators saga is telling us

Lumber Liquidators, America’s largest specialty retailer of hardwood floors, is under heavy selling pressure after reports it sold unsafe laminate flooring made in China.

The stock is down 25 percent since CBS News’ 60 Minutes program raised questions about alleged excessive levels of formaldehyde in the Chinese-made product.

The incident offers great insight for investors.

Nowadays, traditional media and hedge funds are no longer in the frontline of the investment market.

Instead, they have themselves become market forces that impact stock prices.

Chinese investor Zhou Xuhua did an extensive research into the listed company and first revealed the findings to the public.

Zhou dropped out of a finance doctoral program at UCLA two years ago to become a full-time stock investor, according to Bloomberg.

After seeing a surge in Lumber Liquidators’ gross profit margin, Zhou found out that the company sourced some of its products from China.

He began to suspect the company might be concealing safety issues to cut costs.

Zhou later found online complaints about its Chinese-made flooring.

He bought some products from Lumber Liquidators and sent them for testing.

In June 2013, Zhou published the results in Seeking Alpha, an investment website, and suggested shorting the stock, saying that the company lacks a proper product quality control system and was selling products with hazardous levels of formaldehyde.

Zhou said he does not work for any investment fund but made a profit by shorting Lumber Liquidators.

In November, well-known short seller Whitney Tilson of Kase Capital quoted Zhou’s report in an investor conference and praised his research.

Also, 60 Minutes aired Zhou’s report.

That showed the source of the short selling was the research report published on the investment website.

Lumber Liquidators’ share price soared nearly 10 times between August 2011 and November 2013.

The stock plunged to US$33 from nearly US$120 after Zhou published his report.

Until March 1, Zhou’s report had aired on 60 Minutes. Tilson announced his short-selling in November.

The question is whether investors should rely on traditional media which failed to reveal the problem for two years, investment banks which may have conflict of interest, or bloggers who enjoy anonymity online.

If investors have Lumber Liquidators stock, should they dump their investment or patiently wait for the company to offer proof of its innocence?

Selling the stock is the first thing to do.

If the company has been shown to have been aware of the safety problem but sold the products anyway in order to cut costs, it is liable to lawsuits.

That makes it harder to predict how much further the stock will fall.

It’s possible the company will have Enron-style class-action lawsuits on its hands.

Meanwhile, if the company is proven to have been unaware of the misconduct, will investors and customers forgive it?

It’s quite obvious whether investors should sell or hold the stock.

This article appeared in the Hong Kong Economic Journal on March 10. [Chinese version中文版]

Translation by Julie Zhu

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Columnist at the Hong Kong Economic Journal

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