Why I'm Selling My Lumber Liquidators Shares

Back in February 2012, I wrote an article on why I would be purchasing shares of Lumber Liquidators (NYSE: LL  ) for my Roth IRA. As you can see, that has turned out to be a very profitable purchase. At one point, my initial investment had quadrupled in a little more than a year's time.

LL Total Return Price Chart

LL Total Return Price data by YCharts.

But today, I'm offering up one big reason for deciding to sell the stock, take my gains, and invest the money elsewhere.

Concerns about product safety
Search the Internet, and you'll find no short supply of crazy writers telling you why stock X is going to go down to zero because it's a fraud. Usually, the authors of these pieces have a short position in the stock and their reasoning is flimsy at best.

At first blink, that's what I thought occurred with Lumber Liquidators last week, as blogger Xuhua Zhou -- who has a short position in Lumber Liquidators -- wrote a negative piece on the company and its stock went down 11% over the ensuing two days.

But after taking a closer look at the allegations Zhou raised, I think this piece may have some valid points that Lumber Liquidators' shareholders need to be aware of.

Before getting to those points, it's worth pointing out that some of Zhou's claims aren't too much to worry about. For instance, he is suspicious of the company's ability to expand margins so dramatically, but there have been significant improvements in internal efficiencies in the company. And with regards to poor customer reviews, they have been around for quite some time, and that hasn't seemed to put too much of a damper on business.

But the claim that does concern me a great deal is that Lumber Liquidators might be selling wood -- sourced from China -- with illegally high levels of formaldehyde, a known carcinogen.

Lumber Liquidators, on its website, claims that "All laminates and engineered flooring products sold by Lumber Liquidators are purchased from mills whose production method has been certified by a Third Party Certifier approved by the State of California to meet the CARB [California Air Resources Board] standards." 

CARB standards allow for .05 parts per million (ppm) of formaldehyde to be present in hardwood plywood. 

In his article, Zhou claims to have bought a small amount of "Mayflower" brand flooring, as well as Lumber Liquidators' popular Bellawood variety in Southern California and sent it off for testing at Berkely Analytical. Although Zhou states that the Bellawood flooring came back clean, the Mayflower brand -- sourced from China -- had a reading of 0.17 ppm of formaldehyde, more than three times the legal limit. 

Source: Seeking Alpha. 

Realizing this, Zhou had the Mayflower brand tested by a second lab, the NTA. The results from NTA came back showing "noncompliance," though Zhou did not identify what the ppm reading was from the lab.

What this means
Does this mean that Lumber Liquidators is definitely guilty of selling carcinogenic products to unaware consumers? Not necessarily. I find it a little odd that Zhou didn't include the ppm reading from NTA, and Zhou's sample size was admittedly tiny.

But something tells me that this may be a problem for Lumber Liquidators. If formaldehyde does end up being an issue with China-sourced products, the company may have to pay a lot of money for testing and replacing millions of square feet of flooring throughout the country.

Then again, nothing at all may come of these allegations.

But with the stock now trading for almost 40 times earnings and 55 times free cash flow, I think there's more risk than there is reward right now, and there are better places to invest my money.

And to be completely transparent, I am not allowed -- per Motley Fool trading rules -- to sell my shares of Lumber Liquidators until Friday.

One stock that I'm going to be looking to put my Lumber Liquidators money into is growing faster than just about any company out there.  And I'm not the only Fool high on this company.

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