If you bought Luckin Coffee (NASDAQ:LK) at or near its mid-January all-time high of $51.38, I definitely feel your pain. You’ve either sold LK stock at a major loss, or you’re hanging on desperately hoping it can stage a comeback.
Can it? I say no. Here’s why.
You Have Options Other Than LK Stock
Let’s for a second assume that the allegations against the company are completely unfounded. Investors, much like people hesitant to go back to restaurants after the coronavirus peters out, aren’t going to be ready to blindly jump back on the Luckin growth story. In fact, it’s possible that Luckin’s stock may never trade again.
But even if it does, investors are reminded that investing in U.S.-listed Chinese stocks is still a bit of a Wild West. And as I always like to say, “You’ve always got options.” If you want to bet on China, you can buy an ETF like the iShares MSCI China ETF (NASDAQ:MCHI) that owns some of the country’s largest companies.
Simply put, Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU) and the 601 other holdings held by MCHI are a much safer play. Likewise, as I said in March, if you’re going to consider a coffee stock to buy at this time, Starbucks (NASDAQ:SBUX) was, and still is, the quality purchase.
Since my article on March 18, LK stock is down 84%, while Starbucks is up 27%, 12 percentage points higher than the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).
Where There’s Smoke There’s Fire
The allegations against Luckin first came to light on Jan. 31, when short-seller Muddy Waters released an 89-page report about the company inflating several key financial metrics. In response to these allegations, Luckin issued a press release categorically denying them.
“Luckin Coffee categorically denies all allegations in the Report. The methodology of the Report is flawed, the evidence is unsubstantiated, and the allegations are unsupported speculations and malicious interpretations of events,” Luckin said on a Feb. 3 press release.
Jump forward to early April. Luckin’s board altered its stance, forming a special committee to investigate the situation.
“The Special Committee today brought to the attention of the Board information indicating that, beginning in the second quarter of 2019, Mr. Jian Liu, the chief operating officer and a director of the Company, and several employees reporting to him, had engaged in certain misconduct, including fabricating certain transactions,” the company said April 2.
According to the preliminary findings of the special committee, the fabricated transactions totaled $310 million between the second and fourth quarter of 2019. The company’s revenues in the second and third quarters were approximately $347 million. The estimate for Q4 2019 is $324 million. That means the fabricated revenues in question accounted for 46% of the coffee chain’s total sales in these three quarters.
By any standard that’s a significant amount. Regardless of what Luckin’s special committee does in the future, investors should be extremely skeptical of the company’s actions. It seems implausible that the CEO and other board members were completely unaware of the CFOs actions.
Anything short of replacing the entire C-Suite and board is, in my opinion, a failure to act in the best interests of shareholders. As Muddy Waters said in its report, Luckin is a “fundamentally broken business.”
The Bottom Line on LK Stock
If you invest long enough, you’re going to get caught up in a bad investment or two. It’s the law of averages. One of my biggest investing mistakes was buying a decent amount of shares in ACLN Limited in the early 2000s, a Belgian-Cypriot shipping company that shipped new and used cars to Africa. The growth turned out to be financial fiction.
The Securities and Exchange Commission halted the stock in March 2002, filing charges against the company and its controlling shareholders later that year. I encourage you to read the entire summary of the SEC’s filing. It’s an eye opener.
In November 2008, in a Globe & Mail feature Me and My Money, I discussed my investing philosophy for its readers. Included as my worst move was my ACLN experience.
“Early in the decade, Mr. Ashworth was big on ACLN Ltd., a Belgian-Cypriot shipping company moving cars to Africa. While he’d thought the financials looked ‘pristine,’ the U.S. Securities and Exchange Commission shut down trading in the shares in 2002, alleging the company was engaged in a ‘bold and elaborate fraud,’” the Globe’s Tony Martin wrote.
“Each time you get kicked by the market, you learn a little bit more about investing.”
If you’re contemplating buying LK stock should it resume trading, my suggestion is don’t. Where there’s smoke, there’s fire.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.