Luckin Coffee (LK  ) was down 75% as an internal investigation revealed that the company's COO, Jian Liu had inflated sales for the past year. Previously, Luckin had reported sales of $410 million during the first nine months of the year. It turns out that the figure was inflated by $310 million.

Before its fall, the company had been a Wall Street growth darling, as it was rapidly growing in China and looked to be on the verge of dethroning Starbucks (SBUX  ) as that country's dominant coffee retailer.

The stock issued an IPO in May 2019 around $25. It traded in a range between $25 and $17.5 until November 2019. Between November and mid-January, the stock nearly quadrupled during a period when the stock market was getting increasingly frothy. From those levels, the stock declined more than 50% due to the coronavirus outbreak in China which led to the shuttering of its stores. In recent weeks, the stock displayed relative strength compared to US stocks as China was opening its economy back up.

Shadiness

In hindsight, it's clear that the stock's big rally was based on a fiction. Even before the company's internal investigation, there was a great deal of skepticism about the company's claims of success. Many of these were detailed in a short report by Muddy Waters back in January which alleged that the company had inflated sales figures by 70% and store traffic by 80% and was supported by 11,000 hours of security camera footage.

The company vigorously fought back against these allegations, but the internal investigation showed that Muddy Waters' analysis was correct. If anything, it didn't quite grasp the full scale of the deceit. In addition to Muddy Waters, there were many posts on social media that questioned Luckin Coffee's numbers based on empty stores and the fact that it opened at 9:30 AM which is unusual for a coffee shop.

Consequences

In one quick swoop, Luckin went from a Starbucks slayer to a rather ordinary, overpriced stock. This will have many consequences including investors being much more skeptical about the financials reported by Chinese companies especially ones that have less than reputable auditors. It will also give more credence to Muddy Waters and their short targets will be taken more seriously.

Bull markets trade on optimism and greed, while bear markets are dominated by skepticism and fear. In this environment, traders and investors are not going to have less appetite for risk and speculative stocks. There's already several unquantifiable risks and variables in this environment. There will be less tolerance for stocks with shady financials and management teams.