What happened

Shares of Chinese education company GSX Techedu (NYSE:GSX) were falling on Monday, after prominent research firm Muddy Waters revealed it had taken a short position in the stock. As of 11:10 a.m. EDT, the stock was down 8%. But it was down 16% in early trading.

Even after today's stumble, GSX Techedu stock is still up for the year and easily beating the market. Its year-to-date outperformance might be contributing to investors' jitters. 

GSX Chart

GSX data by YCharts

So what

In January, Muddy Waters garnered media attention when it shorted shares of Luckin Coffee. It based its short thesis on an anonymous report stating Luckin Coffee's sales numbers were inflated. The claim was disputed on Wall Street at the time, but it turned out to be true. In April, Luckin announced it was investigating the issue, sending shares down more than 70% in a single day.

After being proven right with Luckin, investors care what Muddy Waters has to say. Today, Muddy Waters released a summary of why it's short GSX Techedu. Based on its own research, it believes that between 70% and 80% of GSX Techedu users aren't real. Therefore, at least that much of its revenue is believed to be inflated.

Muddy Waters also laid out additional ways GSX Techedu's numbers could be worse than reported, including lower average selling prices for its real users and higher expenses for running its business.

A man lays his head down in frustration, with a red, declining stock chart in the background.

Image source: Getty Images.

Now what

It's important to note that Muddy Waters' short positions aren't always proven right. In June 2018, the firm announced it was short TAL Education Group (another Chinese education company) for inflating its profitability. Nearly two years later, the stock is up over 30%. In April, TAL Education stock fell after it reported some fraudulent sales, but this wasn't exactly what Muddy Waters built it short thesis around.

Therefore, shareholders of GSX Techedu should still do their own due diligence. Muddy Waters has been proven right before, and its report should be taken seriously. But it's important to weigh both sides of an argument when investing in stocks.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.