Stocks can be very sensitive to news and rumors, and that's why it's important for investors to consider the credibility of any information that's presented to them. Consider what happened to Trulieve Cannabis (TCNNF 0.57%) on Dec. 17. A scandalous report issued by short-seller Grizzly Research sent the stock into a tailspin, alleging that the company was a "fraud" based on footage captured by drones and "extensive ties" to investigations conducted by the Federal Bureau of Investigation.
Trulieve shares fell by as much as 23% during the day to a low of $9.18. Since then, the stock has nearly recovered, closing at $11.42 on Monday, less than a dollar from the $11.91 it closed at on Dec. 16.
Grizzly Research doesn't list the people involved in its operations or who produced the report but the company says it "is focused on producing differentiated research insights on publicly traded companies through in-depth due diligence."
It has published negative reports about other companies as well, including New Age Beverages, which is involved in making cannabidiol (CBD)-based beverages. Grizzly Research says it's a short-seller on its website's disclaimer, "You should assume that as of the publication date of the reports found on this website, Grizzly Research LLC stands to profit in the event the issuer's stock declines"
Here are three reasons investors should take these short-seller allegations with a grain of salt.
1. The company has audited financials
Earnings reports identify what a company has in assets, how much it has booked in revenue, and what its profits are for a given period. Auditors typically don't review quarterly statements because of the amount of work involved; normally an annual audit and review are sufficient. Trulieve released its most recent audited financials in April 2019.
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The company's auditors, MNP LLC, reviewed Trulieve's financials and found no material misstatements based on its analysis and the information it had access to. That's an important stamp of approval for investors. It's not a guarantee that nothing is wrong with the company, but if there were serious issues with the value of the assets or if the revenue numbers looked wrong, an audit would likely uncover them.
Auditors do more than just review accounting entries, they review the backup and source documents to ensure there are supporting documentation and facts to justify the numbers on a company's financial statements. An audit doesn't look at 100% of the data, but it reviews samples and conducts testing to catch errors and omissions. And most importantly, auditors have access to the company's books. That's why investors should rely more on the analysis and conclusions reached by auditors than the findings of a short-seller.
That doesn't mean that short-sellers haven't been right in the industry, as they've earned an estimated $1 billion in 2019 thanks to the market's declines. There was a short-seller report in July, issued by The Friendly Bear, which warned HEXO was headed for trouble because it had been too aggressive in its advertising. HEXO then faced numerous problems and it even removed its aggressive sales forecast for the coming year. It has been one of the worst-performing pot stocks since July, losing about 70% of its value. By comparison, the Marijuana Life Sciences ETF has fallen 53% during that same time.
Short-sellers aren't always wrong, but investors should be careful when relying on their reports.
2. The report is based on circumstantial evidence
The fundamental problem with any short-seller report is that it's not privy to the internal workings of a company's operations and relies on circumstantial evidence. That becomes evident in Grizzly Research's report, which is based on connecting dots between "extensive ties" to FBI investigations and focuses a great deal on J. T. Burnette, the husband of Trulieve CEO Kim Rivers. The report alleges he "is at the very center" of a probe involving politician Scott Maddox, who pled guilty to corruption charges in August. Burnette is currently facing charges including racketeering and extortion relating to Maddox and has a trial date set for April. Although Burnette is linked to Trulieve through his wife, there's nothing to suggest these charges have anything to do with wrongdoing at the company itself, though the report alleges his company is involved in Trulieve's operations.
The report makes many connections that are loose at best. Without inside information, its claims lack concrete evidence, and that's what investors should be focused on. The short-seller report is based on many assumptions and it can be dangerous for investors to make any buying or selling decisions based on these inferences.
One of its allegations is that drone footage obtained by Grizzly Research suggests that the cannabis grown by Trulieve is likely to be of low quality since it is grown in hoop houses as opposed to traditional greenhouses and that it "won't be able to produce the highly desired flower efficiently." If true, these findings suggest the company's assets are overvalued. However, without knowing the internal processes and controls of Trulieve's operations and exactly what's involved, it would be difficult to ascertain the quality of the cannabis simply by observing that hoop houses are involved.
Nonetheless, the short report was successful in driving a panic, as shares of Trulieve fell to a little more than $9, which is the lowest the stock has been since October. And that's exactly what a short-seller would have wanted to see.
3. A short-seller report is inherently biased
The biggest reason investors shouldn't be quick to take any short-seller report seriously: A short-seller has plenty of incentive to release a scathing analysis that sends the stock price down, especially of a stock that it's shorting.
A short-seller first sells shares of a company they don't own and it has to replenish those shares later through a buy order. And so when a stock price falls, the cheaper it becomes for the short-seller to buy back the stock to return it to the owner, maximizing their gains on the spread. Issuing a negative report can not only send a stock down, but it can accelerate the decline as well.
It's not clear if the research company that wrote the report was short on Trulieve stock, but if it was, it profited from the stock's decline. On the same day that Grizzly Research released its report on Trulieve, the short-selling outfit tweeted "Short Trulieve." Ironically, the research company points to Trulieve's conflicts of interest, yet it neglects to mention if it's benefiting from a sell-off in Trulieve shares though based on its disclosure language, it probably is.
What does this mean for investors?
For investors, there's no substitute for their own analysis and due diligence. Investors could put themselves and their portfolios at risk by relying on reports that may contain incomplete, biased, or downright incorrect information. Instead, investors should rely on company press releases, objective analysis, and other verifiable data when making any investment decisions, whether in marijuana or any other industry. This short-seller report falls into none of those categories.
