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A new challenge has arisen for multilevel-marketing companies operating in China. The Chinese government has recently begun an investigation on Nu Skin Enterprises Inc. (NUS - Snapshot Report) following claims by local newspaper, People’s Daily (on Jan 15) that the company was operating an illegal pyramid scheme in the country.

The news has not only affected the share price of Nu Skin but also that of several other companies with the same distribution model as investors fear that the investigation could extend to these direct selling companies as well. Other companies that have lost their market value drastically in the last two trading days include Herbalife Ltd. (HLF - Snapshot Report) and USANA Health Sciences Inc. (USNA - Snapshot Report).

Shares of the skin-care and nutritional products marketer, Nu Skin have lost around 37.9% in the last two trading days while Herbalife and USANA lost 11.3% and 14.0, respectively.

China has become the highest revenue generating nation for most of the foreign based direct selling companies. China alone contributes over 30% to Nu Skin’s total revenues, while for USANA and Herbalife, it generates nearly 60% and 11%, respectively of their total sales.

These companies are experiencing huge revenue growth opportunities in the world’s second largest economy. This is evident from Herbalife’s third-quarter fiscal 2013 results, in which revenues from China soared 77% year over year.

China has always been suspicious toward these direct selling companies. These were earlier banned by the Communist Party in 1998.  Since then, any kind of pyramid selling scheme is illegal in the country. In 2005, the ban was lifted after multilevel-marketing companies changed their agent payment structure.

In near term, it will be wise to stay away from direct selling companies, which have much exposure in the Chinese market, until the investigation yields some positive news. Another better-ranked retail stock that appears promising in near term is Sally Beauty Holdings Inc. (SBH - Snapshot Report) with a Zacks Rank #2 (Buy).

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