What Makes Herbalife's Business Different From Other Questionable Models?

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Herbalife’s (NYSE: HLF) stock has taken a pounding since a renowned hedge fund manager called it a pyramid scheme and announced he’s been shorting the stock for most of the year.

While the drama between the fund manager, Bill Ackman, and Herbalife plays out, a bright light is being shown again on something that many investors aren’t willing to admit. That is some of the most lucrative businesses operate in spaces that may not rank high when it comes to public opinions.

Ackman’s allegation that Herbalife, the maker and seller of nutritional and weight-loss products, is a pyramid scheme is not new. The company has been trying to fend off such allegations for most of its existence. The reason for the allegation stems from its business model, which is based on the success of a global network of distributors. Ackman, like other naysayers of the company, charges that those distributors’ incomes depend on them recruiting more people to sell the products. Furthermore, Ackman says the company’s earnings are from this practice instead of actual sales of its products, thus making it a pyramid scheme.

Of course, Herbalife denies these allegations. This week it announced several moves to counter the allegations and restore some hope to its beleaguered stock, which has dropped from $32.55 where it stood on Dec. 20 to $24.24 following Ackman’s announcement. It hadn’t seen that low in two years.

I should note that the stocks of other multi-level marketing companies also were dragged down after Ackman’s announcement. These include Avon (NYSE: AVP) and Nu Skin (NYSE: NUS). I think Forbes correctly noted that these stocks saw their value decline simply due to guilt by association. On the Wednesday (Dec. 19) before Ackman held his presentation bashing Herbalife, Nu Skin and Avon closed at $41.54 and $14.69, respectively. To see how their stocks have performed since then, consider this. On yesterday, Avon closed down 3.5%, while Nu Skin was down a considerable 27.03%.

Ackman’s allegations come on the heels of several quarters in which the company posted positive earnings. Also, its stock price has enjoyed a significant run-up over the past few years. For example, since 2008 it has risen from around $8 to about $72 this spring. Its earnings per share have also steadily increased, rising from 1.68% in 2008 to 3.87% as of September.

This shows investors put aside their personal sentiments about the company, and went with their knowledge of how this stock could help line their coffers. The $1.20 dividend yielding 4.6% also likely helped to influence their decision to invest in Herbalife.

Herbalife’s predicament reminds me of the issues some companies operating in the financial sector face. The best examples are companies that provide payday loans. These entities have long been thought of in an unflattering light. They, like Herbalife, have been accused of preying on the poor, offering expensive services to those who can least afford them.

However, if you take a look at some of their stock performance, you can see that those allegations haven’t stopped them from being attractive investments. Take Cash America (NYSE: CSH) for example. It is one of the largest payday lenders. It was trading around $12 in 2009. Its price has increased steadily since then, closing Wednesday at $39.49.

Payday lenders grew largely because of the so-called underbanked who could not qualify for traditional loans through banks. However, the numbers of this type of consumer has increased dramatically, making the business attractive to traditional banks. In fact, Wells Fargo (NYSE: WFC) has joined the industry, loaning money at interest rates that can top 200%. This hasn’t stopped investors from buying its stock.

During an interview on CNBC, Ackman dragged on and on about how Herbalife was taking advantage of the poor and misguided. He even said he’d donate the profits he received from shorting the stock to charity. That’s so admirable. But, I think we must not lose sight of the fact that whether or not Herbalife is a pyramid scheme is not the sole issue. It boils down to the company being regarded as a solid investment for many for years, even through the continued pyramid allegations. You know the saying, “Money talks and you-know-what walks.”

 


TwillyD has no positions in the stocks mentioned above. The Motley Fool owns shares of Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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