Avoid Luckin Coffee Stock Because Trust Still Matters

It takes a special kind of ugly to stand out for the wrong reasons this year. Yet that’s the ignominy that Luckin Coffee (OTCMKTS:LKNCY) finds itself in. After the lessons from high-profile scandals such as Enron, along with the events leading up to the Great Recession, you’d think that all C-suite executives would at least try to run a tight ship. But China’s upstart barista proved us wrong, plummeting Luckin Coffee stock.

Luckin (LKNCY) logo on the wall of a coffee shop with a customer sitting at a table below it.

Source: abolukbas / Shutterstock.com

As many others have detailed, Luckin was caught red-handed manipulating its sales. That’s a huge no-no, particularly because growth was the main catalyst for Luckin Coffee stock. Certainly, people weren’t buying it because it offered a reliable dividend.

Thus, when the entire premise of the investing narrative was built on a lie, there’s little need to even think about risking your capital even further.

Except, of course, that this is the new normal. Unfortunately, strange antics have become too commonplace, as the Wall Street Journal detailed earlier this year. With an influx of workers with an abundance of extra time on their hands, many chose to trade stocks. That’s great and all — so long as you know what you’re doing.

But as we’ve seen with bankrupt companies suddenly rich with speculator capital, not many of the newcomers do. And worryingly, some of these wannabe Gordon Gekkos are now turning their attention to Luckin Coffee stock. What they see is a price-deflated opportunity. Buy low and sell high — isn’t that what you’re supposed to do?

It is, as long as you’re dealing with good companies working through a bad moment. Here, Luckin is a bad company stuck in a hole of its own creation. Adopting a market aphorism out of context could see you with red ink in your portfolio.

About the only adage that applies with Luckin is this one: don’t try to catch a falling knife.

Avoid Luckin Coffee Stock Because Trust Matters

Nevertheless, speculators are buzzing about Luckin Coffee stock. Primarily, this is because LKNCY is charting what appears to be a bullish pennant formation. Basically, after a sharp rise higher, bulls and bears have dragged the price action into a consolidation pattern with an increasingly tighter high-low spread. At the apex of the pattern, the target asset should breakout to the upside.

While I don’t dismiss the possibility of higher gains in the short run, I don’t see a fundamental case for long-term ownership. That’s because in the markets, trust is everything. According to a research paper by Northwestern University Kellogg School of Management, a general lack of trust can be detrimental to market participation as investors “factor in the risk of being cheated.” Further, the paper states:

THE DECISION TO INVEST IN stocks requires not only an assessment of the risk–return trade-off given the existing data, but also an act of faith (trust) that the data in our possession are reliable and that the overall system is fair. Episodes like the collapse of Enron may change not only the distribution of expected payoffs, but also the fundamental trust in the system that delivers those payoffs. Most of us will not enter a three-card game played on the street, even after observing a lot of rounds (and thus getting an estimate of the “true” distribution of payoffs). The reason is that we do not trust the fairness of the game (and the person playing it).

I don’t need to go any further. Yes, Luckin might have gotten away with one because the overall penalty has been relatively light. Also, the American electorate voted for a new administration in Joe Biden and Kamala Harris. It’s possible that they will be much more diplomatic than the President Donald Trump White House when it comes to U.S.-China relations.

However, that will not remove the bad taste in investors’ mouth. You may not care about Luckin’s cheating ways. Usually, though, people don’t like to be cheated. Certainly, if you trick somebody once, they’re not going to be willing to be tricked again.

A Biden Administration Is No Tailwind

Let me also point out that President-elect Biden may not be the panacea for Luckin Coffee stock that some assume it is. According to a Reuters report, “Beijing is tiring of the constant stream of scandals.” Again, Luckin may have gotten away with its fraudulent sales. However, China could end up paying dearly for the infraction.

After all, who would want to do business with publicly traded companies connected to countries that seemingly allow investors to be cheated out of their money? From Beijing’s standpoint, this isn’t about securing cheap scores against the U.S. If Chinese companies want access to American capital — and they do — they need to start playing by the rules.

Considering that Luckin Coffee was the one name that really embarrassed the Chinese government, the company has a credibility crisis. If its domestic market has trouble trusting LKNCY, there’s no reason why an American investor should offer the olive branch.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. 

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