Wednesday, November 17, 2010

Class-action lawsuit against RINO

Not long ago I put out a BUY rating for RINO, a fast-growing Chinese environmental services company.  Since then the stock price has plunged in response to a class-action lawsuit, dropping around 70% from $18 to $6.  Of course, we don't know yet if the allegations are true or not, but this is a good example of sell the rumor before the truth of it is known because no one wants to be left holding the bag.  There was no way to know that a class-action lawsuit was going to be filed, or if there is any merit to its claims.

I have two comments:
1.  This is a good reason why you don't want to put your whole portfolio, or too much of it, into one stock.  When something like this happens, if only 5% or 10% of your portfolio is in the stock, then you won't have a heart attack when this happens.  If 10% of a $100,000 portfolio is in RINO, then your loss right now is around $7000 or 7%.  But if 100% of your portfolio is in the stock, then your $100,000 portfolio is now worth $30,000 ..... Ouch!  For much smaller portfolios like mine, if half your money is in one stock, then a big percentage loss doesn't actually translate into a large dollar loss..... so small portfolios can take bigger risks. 

2.  Although no one likes taking a big hit like this, it's all part of the game.  The news is currently being priced into the stock.  The question is, now what do we do?  It could very well be that the alleged fraud is true -- corruption in business is rampant outside the United States.  The correct answer is that holding or selling is the right decision now.  The stock price will remain depressed until the verdict and liability is determined from the suit.  If the suit fails, the stock price will go back up.  If the suit is successful and the company executives are proven guilty of fraud, the stock may remain depressed indefinitely due to a lack of credibility.  And it may take years to settle the suit.  Personally, since it's just a small part of my portfolio, I'll hold onto it and see what happens.  If they didn't commit fraud, great!  The stock will climb back up nicely.  If they are guilty, they are more likely to keep their hands out of the cookie jar after a good, hard slap.

RINO Shares Plunged: What You Need to Know

By Matt Koppenheffer   November 15, 2010

RINO International     $6.00 $-1.15 (-16.11%)

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of China cleantech company RINO International (Nasdaq: RINO) got clobbered today, losing 28% in intraday trading as the stock's woes continued.

So what: The big news recently for RINO was the harsh light cast on the company by small-fry research firm Muddy Waters. As part of a "strong sell" recommendation, Muddy Waters alleged wide-ranging fraud at the company, most notably in overstating revenue and its competitive position in the industry. Today, pessimists dug in their heels as the company reported disappointing third-quarter results and cut its outlook. On top of that, Canaccord Genuity lent some credence to Muddy Waters' allegations in a research report, and cut RINO's shares to "sell."

Now what: In the courts, Americans are always presumed innocent until proven guilty. In the stock market, though, by the time guilt is proved, the fat lady has often already finished singing for investors. In RINO's case, investors are obviously concerned about getting caught in front of a fraudulent freight train. The last chapter of this saga hasn't yet been written, and if it turns out that RINO is on the up-and-up, there could be hell to pay for Muddy Waters -- not to mention big gains for investors who stay in the game. At this point, though, any investor eyeing the stock should realize that this has become a highly speculative bet.