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Why Mohawk Industries Stock Dropped 11% This Morning

What happened

Shares of flooring products manufacturer Mohawk Industries (NYSE: MHK) were pummeled this morning, falling 11.5% after the company revealed in an 8-K filing with the Securities and Exchange Commission that it is the subject of a civil lawsuit, and that it has received subpoenas from both the U.S. Attorney's Office for the Northern District of Georgia and the SEC.  

In afternoon trading, Mohawk shares have recovered some of their losses but remain down 4.3% as of 12:15 p.m. EDT on Tuesday.

Glowing red stock chart arrow trending down

Image source: Getty Images.

So what

The lawsuit alleges violations of federal securities law. It specifically claims that Mohawk has "engaged in fabricating revenues by attempting delivery to customers that were closed and recognizing these attempts as sales," that the company has "overproduced product to report higher operating margins and maintained significant inventory that was not salable," and that it has "improperly delivered inventory with knowledge that it was defective and customers would return it."

Now what

If proven, these allegations could have serious implications for investors. At a current valuation of just nine times trailing earnings, Mohawk stock looks really cheap right now, but only if its numbers are accurate.

In addition to any civil damages the company might be forced to pay, fabrication of revenue and fiddling with inventory numbers are the kinds of things that could force Mohawk to make an accounting restatement. That would give rise to additional shareholder lawsuits, and render Mohawk's financial results unreliable for some time, while the accountants work to produce more-reliable numbers.

Even leaving aside possible financial liabilities, a development such as that could weigh on Mohawk shares for years.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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