It's Not Easy Being Long When Einhorn's Short

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A wise frog once said "it's not easy being green." Well, it's also not easy being long when David Einhorn is short. That is, unfortunately, the position contrarian investors have to take when valuing Herbalife, Nu Skin, and Sirius. Below, I explain why these contrarian investors should stick to their guns when the prevailing wind is not on their side.

Why Einhorn, Citron are Wrong on Herbalife (NYSE: HLF) & Nu Skin Enterprises (NYSE: NUS)

While Herbalife's stock price has recovered 20.8% from its 52-week low following the precipitous decline in early May 2012, the stock still remains overly depressed. At a PEG ratio of 0.9x, the future is nowhere close to being fully factored into the stock price. And this, of course, isn't even accounting for how management has consistently beaten analyst expectations despite a more challenging economy than anticipated.

It's only fitting that after Herbalife was beaten down by famed short seller David Einhorn's bearish suggestions, peer Nu Skin would be beaten down by famed short seller Citron Research. Whereas the former was implicitly accused of running a pyramid scheme, the latter was explicitly accused of violating China's direct selling rules. The tactics of both short sellers have been to create a lot of smoke in the absence of credibility. In reality, both companies have fantastic fundamentals. Herbalife, for example, has grown EPS by 28% annually over the past five years, has expanded gross margins to 80.2%, and has been rated a "buy" on the Street. Nu Skin has grown EPS annually by even more: 38.5%.

Both also drive terrific free cash flow that can keep corporate debt expenses to a minimum. Nu Skin has a yield of 8.4% against its market cap and, like Herbalife, is valued under its growth potential. Analysts recognize this value gap and rate the stock a 1.3 out of 5, where "1" is a "buy." Gross margins have also been on the rise, expanding to 83.7%. And, in regard to Herbalife specifically, I am optimistic about the volumes shift towards nutritional clubs and how it is challenging the pyramid allegation. With an increasingly low percentage of sales coming from new leaders, Herbalife is evidently not getting most of its business from new distributors.

Shorting the Shorts at Sirius (NASDAQ: SIRI)

Sirius is yet another stock that the bears have gotten wrong. For the year to date, it has soared by 55% and is now a $10.8 billion company. Fortunately, as a near monopolist of satellite radio, it has strong leverage to grow into various media segments. Unlike what the bears will have you believe, the relationship with Liberty Media is also a net positive for shareholders. Equipped with a powerful content library, Liberty is free to cross-sell Sirius's offerings to viewers worldwide.

The bears have also been dead wrong about Pandora being a threat. The internet radio startup has done nothing to stymie Sirius's relentless penetration. Over the last few months, the mark has started to realize that Sirius' market position is, far from being unsustainable, fundamentally strong. The company recently picked up 0.4% in the aftermarket in light of converging analyst opinion that Sirius can meet any competition that Apple poses in satellite radio.

With a multi-billion dollar cash chest of NOLs and growing free cash flow generation, Sirius represents an attractive takeover candidate. Should Liberty take it over, I recommend buying shares in the suitor. Analysts anticipate Sirius to grow EPS  by 27.2% annually over the next five years. Combined with the corporate financial position and momentum, this is more than enough to generate strong accretion for Liberty.

Know What You Own

Despite being one of the market's biggest winners since bottoming out three years ago, there is still some healthy upside to be had if things go right for Sirius XM -- and plenty of room to fall if things don't. Read all about Sirius in The Motley Fool’s brand new premium report. To get started, just click here now.

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