Why Tile Shop Hldgs, Inc. Shares Dropped and Then Popped

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 Tile Shop Hldgs, (NASDAQ:TTS) continued its sell-off this morning after a short seller yesterday raised questions about fraudulent accounting, falling as much 22% before finishing up 12% as larger research firms came to the retailer's defense.

So what: Investment firm Gotham City Research issued a blistering report on Tile Shop yesterday, stating that the home-improvement retailer's earnings over the last four quarters were overstated by more than 200%, and that Tile Shop's actual earnings were "closer to $0.18/share." Gotham City also said that Tile Shop will be forced to restate several years of earnings, and that its actual share value is in the range of $1.54-$3.34. The group laid out its argument in a 58-page report.

In its response issued yesterday afternoon, Tile Shop said it "adamantly denies these allegations and believes that the financial statements are properly stated and its business practices are appropriate." The Tile Shop also denied individual charges, saying that suppliers are not paid with stock transfers, and that it's suspended its relationship with Beijing Pingxiu, the principal supplier implicated in Gotham City's report.

Now what: Trading of Tile Shop shares was suspended yesterday afternoon, and finally began moving back up around 10 this morning. Some of the more legitimate financial firms to come to its defense were Credit Suisse, Wedbush, and Piper Jaffray. Piper Jaffray said it believed the short seller misunderstood Beijing Pingxiu's role in the company and the nature of the supply chain, while Credit Suisse also said it believed the allegations were inaccurate.

Even after the recovery today, Tile Shop's shares are still down 30% from before Gotham City's assault. As for Gotham City itself, the firm posts little information on its website, and has issued two previous reports, both from this year and both on Ebix, whose stock cratered this summer and has not recovered. Clearly, this story is not over, but if the allegations prove to be false, there is considerable upside for Tile Shop as analyst expect a near-30% top-line growth next year. Stay connected by adding Tile Shop to your Watchlist.